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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 2, 1998.
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 20-F/A
(MARK ONE)
[X] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B)
OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
COMMISSION FILE NUMBER: 001-14475
TELESP PARTICIPACOES S.A.
(Exact name of Registrant as specified in its charter)
TELESP HOLDING COMPANY
(Translation of Registrant's name into English)
THE FEDERATIVE REPUBLIC OF BRAZIL
(Jurisdiction of incorporation or organization)
SCN-QUADRA CN2, LOTE F, 2(degrees) ANDAR, SALA 206
BRASILIA-DF, BRAZIL
(Address of principal executive offices)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Preferred Shares, without par
value.......................... New York Stock Exchange*
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* Not for trading, but only in connection with the listing of American
Depositary Shares on the New York Stock Exchange.
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE
ACT: None
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(D)
OF THE ACT: None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the last fiscal year covered by
this Registration Statement: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 Item 18 X
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TABLE OF CONTENTS
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PAGE
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PRESENTATION OF INFORMATION................................... ii
GLOSSARY OF TERMS............................................. vi
EXCHANGE RATES................................................ ix
PART I
ITEM 1. Description of Business....................................... 1
ITEM 2. Description of Property....................................... 29
ITEM 3. Legal Proceedings............................................. 29
ITEM 4. Control of Registrant......................................... 30
ITEM 5. Nature of Trading Market...................................... 31
ITEM 6. Exchange Controls and Other Limitations Affecting Security
Holders....................................................... 34
ITEM 7. Taxation...................................................... 35
ITEM 8. Selected Financial Data....................................... 40
ITEM 9. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 44
ITEM 9A. Quantitative and Qualitative Disclosures about Market Risk.... 59
ITEM 10. Directors and Officers of Registrant.......................... 59
ITEM 11. Compensation of Directors and Officers........................ 61
ITEM 12. Options to Purchase Securities from Registrant or
Subsidiaries.................................................. 61
ITEM 13. Interest of Management in Certain Transactions................ 61
PART II
ITEM 14. Description of Securities to be Registered.................... 62
PART III
ITEM 15. Defaults upon Senior Securities............................... 75
ITEM 16. Changes in Securities and Changes in Security for Registered
Securities.................................................... 75
PART IV
ITEM 17. Consolidated Financial Statements............................. 75
ITEM 18. Consolidated Financial Statements............................. 75
ITEM 19. Consolidated Financial Statements and Exhibits................ 75
</TABLE>
i
<PAGE>
PRESENTATION OF INFORMATION
OVERVIEW
Telesp Participacoes S.A. (the "Registrant"), a corporation organized under
the laws of the Federative Republic of Brazil ("Brazil"), was formed upon the
reorganization of Telecomunicacoes Brasileiras S.A.--Telebras ("Telebras"), a
corporation organized under the laws of Brazil that, together with its
operating subsidiaries (the "Telebras System"), was the primary supplier of
public telecommunications services in Brazil. On May 22, 1998, the
shareholders of Telebras approved the restructuring of the Telebras System to
form, in addition to Telebras, twelve new telecommunications companies (the
"New Holding Companies") by means of a procedure under Brazilian corporate law
called cisao or "split-up". The New Holding Companies were allocated
substantially all the assets and liabilities of Telebras, including the shares
held by Telebras of the operating companies of the Telebras System. The New
Holding Companies, together with their respective subsidiaries, comprise (a)
three regional fixed-line operators, (b) eight regional cellular operators and
(c) one national long-distance carrier. The separation of the Telebras System
into the New Holding Companies and their respective subsidiaries is referred
to in this Registration Statement on Form 20-F (the "Registration Statement")
as the "Breakup" of Telebras. Prior to the Breakup, Telebras, through its
operating subsidiaries, was the primary supplier of public telecommunications
services in Brazil. See "Description of Business--Background" and "--The
Company."
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. In the Breakup, all of the share capital held by Telebras of
Telecomunicacoes de Sao Paulo S.A.--Telesp ("Telesp") (71.4% of Telesp's total
share capital, including 87.3% of its voting stock) and of Companhia
Telefonica da Borda do Campo--CTBC ("CTBC") (69.8% of CTBC's total share
capital, including 86.7% of its voting stock) was transferred to the
Registrant. Telesp is the principal provider of fixed-line public
telecommunications services in the Brazilian state of Sao Paulo. Prior to
January 1, 1998, Telesp also had a cellular telephone business. In preparation
for the Breakup of Telebras, on January 30, 1998 the cellular telephone
business of Telesp was "spun off" effective January 1, 1998 to a newly formed
company called Telesp Celular S.A. See "Description of Business--Background"
and "--The Company."
A substantial part of the Registrant's assets are shares of its operating
subsidiaries. The Registrant relies largely on dividends from its subsidiaries
to meet its need for cash, including for the payment of dividends to its
shareholders. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
As used herein, the "Company" refers to the Registrant and its consolidated
subsidiaries Telesp and CTBC.
PRESENTATION OF FINANCIAL INFORMATION
FINANCIAL STATEMENTS AND MINORITY INTERESTS
The audited consolidated balance sheets included herein as of December 31,
1996 and 1997 and the related consolidated statements of income, cash flows
and changes in shareholders' equity for each of the years ended December 31,
1995, 1996 and 1997, (including the notes thereto, the "Consolidated Financial
Statements") are the consolidated financial statements of the Registrant and
its subsidiaries, Telesp and CTBC. The portion of the consolidated equity and
net income of Telesp and CTBC attributable to shareholders of Telesp and CTBC
other than Telebras at December 31, 1996 and 1997, and for each of the years
in the three-year period ended December 31, 1997 is reflected as "minority
interests" in the Consolidated Financial Statements. At December 31, 1997,
such minority shareholders directly and indirectly owned 28.6% and 30.2% of
the share capital of Telesp and CTBC, respectively. Substantially all such
share capital is comprised of preferred shares originally issued from time to
time by the Registrant's subsidiaries in connection with such subsidiaries'
auto-financing activities. The consideration paid for such preferred shares
was the higher of market or book value at the time of issuance, for
ii
<PAGE>
shares issued after August 1996, and book value for shares issued prior to
August 1996. A secondary trading market has developed in such preferred shares
in which institutional and other investors participate. For a discussion of
such auto-financing activities, see "Description of Business--Rates--Local
Services."
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Registrant and its subsidiaries, Telesp and
CTBC, as continuing operations and the cellular telephone business as
discontinued operations for all periods. The assets and liabilities of the
cellular telephone business are presented as net assets of discontinued
operations.
FORMATION OF REGISTRANT
The separation of the fixed and cellular telecommunications businesses and
the formation of the Registrant has been accounted as a reorganization of
entities under common control in a manner similar to a pooling of interests.
The assets and liabilities of the cellular telephone business were transferred
from Telesp to Telesp Cellular at their indexed historical cost. The
Consolidated Financial Statements are not necessarily indicative of the
financial position and results of operations that would have occurred for the
three-year period ended December 31, 1997 had the fixed-line
telecommunications businesses of Telesp and CTBC been separate legal entities
during such periods. See "Description of Business--Background," "--The
Company" and Notes 1, 2 and 31 to the Consolidated Financial Statements.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Telesp Participacoes S.A. were established. Telebras retained
within its own shareholders' equity sufficient retained earnings from which to
pay certain dividends and other amounts. Telebras allocated to each New
Holding Company the balance of its retained earnings in proportion to the
total net assets allocated to each such Company. This value of allocated
retained earnings does not represent the historical retained earnings of the
New Holding Companies and resulted in an increase of R$171,236,000 in relation
to the Company's historical retained earnings. See Note 31 to the Consolidated
Financial Statements. Allocated retained earnings and future retained earnings
will be the basis from which future dividends will be payable.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from Telesp.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, interest income and expense
relating to the cellular telecommunications business could not be identified
and, consequently, income from discontinued operations is presented before
unallocated interest income/expense and income tax expense. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations for the years ended December 31, 1995, 1996 and 1997--
Allocated and unallocated interest expense and unallocated interest income."
In connection with the formation of the Registrant, certain assets and
liabilities of Telebras in addition to its interests in Telesp and CTBC were
spun off to the Registrant. The principal such assets and liabilities were
certain loans and other financings (which comprised substantially all the
external indebtedness of Telebras), cash and other current assets, noncurrent
assets and certain investments. See Note 31 to the Consolidated Financial
Statements, which includes a consolidated balance sheet of the Registrant
reflecting all the assets and liabilities spun off to the Registrant as of
February 28, 1998. The Registrant received R$479.9 million of Telebras
indebtedness and R$729.9 million of Telebras current assets, including R$439.2
million in cash and cash equivalents. A substantial amount of the assets
received from Telebras (principally investment in subsidiaries) is eliminated
upon consolidation.
EFFECTS OF INFLATION
The Consolidated Financial Statements contained herein were prepared in
accordance with generally accepted accounting principles in Brazil ("Brazilian
GAAP") and are presented in Brazilian reais. Pursuant to Brazilian GAAP, the
Consolidated Financial Statements and the other financial information
presented herein
iii
<PAGE>
recognize certain effects of changes in the purchasing power of Brazilian
currency due to inflation and, unless otherwise specified, have been indexed
and expressed in constant reais of December 31, 1997 purchasing power by using
the daily changes or the monthly average values of the Unidade Fiscal de
Referencia (the Tax Reference Unit or the "UFIR") through December 31, 1995.
Until December 31, 1995, the relevant inflation index selected by the
Comissao de Valores Mobiliarios (the Brazilian Securities Commission or "CVM")
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM, no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the Indice Geral
de Precos--Mercado (the General Prices Index-Market or the "IGP-M") be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its financial statements in accordance
with the constant currency method as of January 1, 1996. See Note 2 to the
Consolidated Financial Statements.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the Consolidated Financial
Statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare the Consolidated
Financial Statements beginning January 1, 1998, the restated balances of
nonmonetary assets and liabilities of the Company as of December 31, 1997 will
become the new basis for accounting, and income statement items will no longer
be restated for inflation.
CURRENCY TRANSLATIONS
All references herein to (i) the "real," "reais" or "R$" are to Brazilian
reais (plural) and to the Brazilian real (singular), the official currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States
dollars. As of July 1, 1994, the denomination of the Brazilian currency unit
was changed to the real from the cruzeiro real (each real being equal to 2,750
cruzeiros reais at such time). All amounts in cruzeiros reais have been
restated in reais in this Registration Statement. Certain amounts herein may
not sum due to rounding.
This Registration Statement contains translations of certain real amounts
into U.S. dollars solely for the convenience of the reader. These translations
should not be construed as representations that the real amounts actually
represent such U.S. dollar amounts or could be or could have been converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S.
dollar amounts have been translated from reais at the commercial buying rate
for the purchase of U.S. dollars (the "Commercial Market Rate") published by
Banco Central do Brasil (the "Central Bank of Brazil") for December 31, 1997,
which was 1.1164 to US$1.00. The noon buying rate in New York City for cable
transfers in reais as certified by the Federal Reserve Bank of New York has
not been consistently reported for Brazilian currency during the periods for
which data are presented in this Registration Statement. See "Exchange Rates"
for information regarding rates of exchange.
MARKET INFORMATION
Upon the Breakup of Telebras, holders of common and preferred Telebras
shares ("Telebras Common Shares" and "Telebras Preferred Shares" and,
together, "Telebras Shares") were deemed under Brazilian law to own, in
addition to such Telebras Shares, one common or preferred share, as
applicable, of each New Holding Company for each such Telebras Share held by
them. Following the Breakup and until September 21, 1998, the Telebras Common
Shares and the common shares of the New Holding Companies traded only as a
unit on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges"). Similarly, the Telebras Preferred Shares and the preferred shares
of the New Holding Companies traded only as a unit on the
iv
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Brazilian Stock Exchanges during this period. Telebras American Depositary
Shares ("Telebras ADSs"), each originally representing ownership of 1,000
Telebras Preferred Shares, have continued to trade on the New York Stock
Exchange, Inc. (the "NYSE") except that since the Breakup, each Telebras ADS
has represented 1,000 Telebras Preferred Shares and of 1,000 preferred shares
of each of the New Holding Companies. On September 21, 1998, the common shares
and preferred shares of each New Holding Company were distributed in Brazil
and commenced trading separately on the Brazilian Stock Exchanges. It is
expected that during the fourth quarter of 1998 American Depositary Shares
representing preferred shares of each New Holding Company will be issued and
will commence trading separately on the NYSE. See "Nature of Trading Market"
and "Description of Securities to be Registered--Description of American
Depositary Receipts in respect of Preferred Shares."
References herein to the "Preferred Shares" and "Common Shares" are to the
preferred shares and common shares, respectively, of the Registrant.
References to the American Depositary Shares or "ADSs" are to American
Depositary Shares, each representing 1,000 Preferred Shares. The ADSs will be
evidenced by American Depositary Receipts ("ADRs").
v
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GLOSSARY OF TERMS
The following explanations are not intended as technical definitions, but to
assist the general reader to understand certain terms as used in this
Registration Statement.
Access charge: Amount paid per minute charged by network operators for the
use of their network by other network operators. Also known as an
"interconnection charge" or "network usage charge".
Access gates: The points of interface between the network equipment (either
dedicated or switched) and the transmission media that connect network
equipment to the end user. The quantity of service is directly related to the
quantity of network access gates.
AMPS (Advanced Mobile Phone Service): An analog cellular telephone service
standard utilizing the 850 MHz band, in use in North America, parts of South
America, Australia and various other areas.
Analog: A mode of transmission or switching which is not digital, e.g., the
representation of voice, video or other modulated electrical audio signals
which are not in digital form.
Analog network: A network using analog technology with circuit switching,
capable of connecting one user with all the users, but with limited
transmission capacity.
ATM (Asynchronous Transfer Mode): A broadband switching technology that
permits the use of one network for different kinds of information (e.g.,
voice, data and video).
Automatic international roaming: A service which permits a subscriber to use
his or her cellular phone on a foreign cellular operator's network. The
subscriber may receive calls made to the subscriber's regular cellular number
(such calls are "automatically" passed to the foreign operator's network).
Band A Operator: A former Telebras cellular operating subsidiary that has
been granted a concession to provide cellular telecommunications services in a
particular area within a radio spectrum frequency range referred to by Anatel
as "Band A".
Band B Operator: A cellular operator that has been granted a concession to
provide cellular telecommunications services in a particular area within a
radio spectrum frequency range referred to by Anatel as "Band B".
Base station: In cellular mobile telecommunications, a radio
transmitter/receiver that maintains communications with the cellular
telephones within a given cell. Each base station in turn is interconnected
with other base stations and with the public switched telephone network.
Broadband services: Services characterized by a transmission speed of 2
Mbit/s or more. According to international standards, these services are
divided into two categories: (i) Interactive services, including
videotelephone/videoconferencing (both point-to-point and multipoint);
videomonitoring; interconnection of local networks; file transfer; CAD;
highspeed fax; e-mail for moving images or mixed documents; broadband
videotext; video on demand; retrieval of sound programs or fixed and moving
images; and (ii) Broadcast services, such as sound programs, television
programs (including high-definition TV and pay TV) and selective document
acquisition.
CATV (Cable television): Cable or fiber-based distribution of TV programs.
CDMA (Code Division Multiple Access): A standard of digital cellular
technology.
Cell: The geographic area covered by a single base station in a cellular
mobile phone system.
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Cell splitting: The process of dividing cells into smaller coverage areas by
reducing their power output and the antenna height of the station transmitter.
Cell splitting increases capacity in a particular area by allowing for the
further reuse of frequencies by a mobile communications system.
Cellular service: A mobile telephone service provided by means of a network
of interconnected low-powered base stations, each of which covers one small
geographic cell within the total cellular system service area.
Channel: One of a number of discrete frequency ranges utilized by a base
station.
Digital: A mode of representing a physical variable such as speech using
digits 0 and 1 only. The digits are transmitted in binary form as a series of
pulses. Digital networks allow for higher capacity and higher flexibility
through the use of computer-related technology for the transmission and
manipulation of telephone calls. Digital systems offer lower noise
interference and can incorporate encryption as a protection from external
interference.
Digital penetration: The substitution of equipment capable of transmitting
digital signals for equipment limited to analog transmission.
Exchange: See Switch.
Frame relay: A data transmission service using fast protocols based on
direct use of transmission lines.
Internet: A collection of interconnected networks spanning the entire world,
including university, corporate, government and research networks from around
the globe. These networks all use the IP (Internet Protocol) communications
protocol.
ISDN (Integrated Services Digital Network): A system in which several
services (e.g., speech and data) may be simultaneously transmitted end-to-end
in digital form.
Leased high-speed data communication: The digital exchange of information at
speeds exceeding 64Kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest switch.
It generally consists of a pair of copper wires, but may also employ fiber-
optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use his
or her cellular phone on a foreign cellular operator's network. The subscriber
may only receive calls made to a temporary number issued to the subscriber by
the foreign operator for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells can
cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment.
The transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge".
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway
along which waves of light can travel for telecommunications purposes.
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Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the
individual packets. Information transmitted is segmented into cells of a
standardized length, which are then transmitted independently of one another,
allowing maximization of available capacity and usage of a single transmission
path for multiple communications. The cells are then reassembled upon reaching
their destination.
PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. As of any date, the
penetration is calculated by dividing the number of subscribers by the
population to which the service is available and multiplying the quotient by
100.
Private leased circuits: Voice, data or image transmission mediums leased to
users for their exclusive use.
PSTN (Public Switched Telephone Network): The public telephone network that
delivers basic telephone service and, in certain circumstances, more advanced
services.
Repeaters: A device that amplifies an input signal for retransmission.
Roaming: A function that enables cellular subscribers to use their cellular
phone on networks of operators other than the one with which they signed their
initial contract.
Satellite services: Satellites are used, among other things, for links with
countries that cannot be reached by cable or to provide an alternative to
cable and to form closed user networks.
SDH (Synchronous Digital Hierarchy): A hierarchy set of digital transport
structures, standardized for the transport of suitably adapted payloads over
physical transmission networks.
Sectorization: The process of dividing cells into sectors by using
directional antennae at the base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide a higher level of
functionality than the basic transmission services offered by a
telecommunications network.
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EXCHANGE RATES
There are two legal foreign exchange markets in Brazil--the commercial rate
exchange market (the "Commercial Market") and the floating rate exchange
market (the "Floating Market"). The Commercial Market is reserved primarily
for foreign trade transactions and transactions that generally require prior
approval from Brazilian monetary authorities, such as the purchase and sale of
registered investments by foreign persons and related remittances of funds
abroad. Purchases and sales of foreign exchange in the Commercial Market may
be carried out only through a financial institution in Brazil authorized to
buy and sell currency in that market. As used herein, the "Commercial Market
Rate" for any day is the commercial selling rate for Brazilian currency into
U.S. dollars, as reported by the Central Bank of Brazil. As used herein, the
"Floating Market Rate" is the prevailing selling rate for Brazilian currency
into U.S. dollars which applies to transactions to which the Commercial Market
Rate does not apply, as reported by the Central Bank of Brazil. Prior to the
implementation of the Real Plan, the Commercial Market Rate and the Floating
Market Rate differed significantly at times. Since the introduction of the
real, the two rates have not differed significantly, although there can be no
assurance that there will not be significant differences between the two rates
in the future. Both the Commercial Market Rate and the Floating Market Rate
are freely negotiated but are strongly influenced by the Central Bank of
Brazil.
On July 1, 1994 the real replaced the cruzeiro real as the unit of Brazilian
currency, with each real being equal to 2,750 cruzeiros reais. The issuance of
reais was initially subject to quantitative limits backed by a corresponding
amount of U.S. dollars in resources, but the Federal Government subsequently
expanded those quantitative limits and allowed the real to float, with parity
between the real and the U.S. dollar (R$1.00 to US$1.00) as a ceiling. On
March 6, 1995, the Central Bank of Brazil announced that it would intervene in
the market and buy or sell U.S. dollars, and established a trading band (faixa
de flutuacao) for the Commercial Market Rate (which is defined through
auction) within which the exchange rate between the real and the U.S. dollar
could fluctuate. The Central Bank of Brazil initially set the band with a
floor of R$0.86 per US$1.00 and a ceiling of R$0.90 per US$1.00 and provided
that, from and after May 2, 1995, the band would fluctuate between R$0.86 and
R$0.98 per US$1.00. Shortly thereafter, the Central Bank of Brazil issued a
new directive providing that the band would be between R$0.88 and R$0.93 per
US$1.00. On June 22, 1995, the Central Bank of Brazil issued another directive
providing that the band would be between R$0.91 and R$0.99 per US$1.00 and
subsequently reset the band on January 30, 1996 to between R$0.97 and R$1.06
per US$1.00. Upon resetting the band on January 30, 1996, the Central Bank of
Brazil adjusted the exchange rate within such band on a number of occasions,
generally in increments of R$0.001, by means of buying and selling U.S.
dollars in electronic auctions. On February 18, 1997, the band was reset by
the Central Bank of Brazil to float between R$1.05 and R$1.14 per US$1.00. On
May 5, 1998, the band was reset by the Central Bank of Brazil to float between
R$1.12 to R$1.22 per US$1.00. As of October 23, 1998, the trading band has not
been reset by the Central Bank of Brazil. There can be no assurance that the
band will not be altered in the future or that the real will maintain its
current exchange rate in future periods.
The following table sets forth the Commercial Market Rate expressed in reais
per U.S. dollar for the periods and dates indicated. Prior to July 14, 1994,
the Federal Reserve Bank of New York did not publish a noon buying rate for
customs purposes in the City of New York for cable transfers in the Brazilian
real and its predecessor currencies (the "Noon Buying Rate").
<TABLE>
<CAPTION>
COMMERCIAL MARKET RATE:
NOMINAL REAIS PER US$1.00(1)
-----------------------------------
YEAR ENDED DECEMBER 31,(1) LOW HIGH AVERAGE(2) PERIOD-END
- -------------------------- ------ ------ ---------- ----------
<S> <C> <C> <C> <C>
1993....................................... 0.0044 0.1186 0.0369 0.1186
1994....................................... 0.1204 0.9815 0.6754 0.8490
1995....................................... 0.8340 0.9726 0.9227 0.9726
1996....................................... 0.9726 1.0394 1.0080 1.0394
1997....................................... 1.0395 1.1164 1.0555 1.1164(3)
1998 (through October 23).................. 1.1165 1.1911 1.1560 1.1911
</TABLE>
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Source: Central Bank of Brazil
(1) Amounts expressed in nominal reais have been translated from the
predecessor Brazilian currencies in effect during the relevant period at
the rates of exchange at the times the successor currencies became the
lawful currency of Brazil.
(2) Represents the average of the month-end exchange rates during the relevant
period.
(3) The Noon Buying Rate on December 31, 1997 was R$1.1165 per U.S. dollars.
ix
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PART I
ITEM 1: DESCRIPTION OF BUSINESS
BACKGROUND
TELEBRAS AND THE TELEBRAS SYSTEM
Until 1972, telephone services in Brazil were provided by more than 900
independent companies, which supplied non-integrated basic telephone services.
Telebras was incorporated on November 9, 1972, pursuant to special
legislation, for the principal purposes of (i) acting as a holding company for
operating companies providing public telecommunications services in Brazil and
(ii) implementing the policies of the federal government of Brazil (the
"Federal Government") in the modernization and expansion of the Brazilian
telecommunications system. Between 1972 and 1975, Telebras, through its
subsidiaries, acquired almost all the other telephone companies in Brazil.
Telebras and its operating subsidiaries are referred to collectively herein as
the "Telebras System." Only four operating companies remained outside the
Telebras System at December 31, 1997, representing approximately 9% of all
lines in service in Brazil at that date. Telebras is controlled by the Federal
Government, and the operations of the Telebras System are subject to
regulation by the Federal Government. The operating subsidiaries of Telebras
were controlled by the Federal Government until August 4, 1998. See "--
Regulatory Reform and Privatization."
At December 31, 1997, Telebras, through 28 operating subsidiaries, was the
primary supplier of public telecommunications services in Brazil. Empresa
Brasileira de Telecomunicacoes S.A.--Embratel ("Embratel"), a subsidiary of
Telebras, owned and operated all of the interstate and international telephone
transmission facilities in Brazil. Through the other 27 subsidiaries, the
Telebras System was the primary provider of local and intrastate
telecommunications service and the leading provider of cellular mobile
telephone service. The Telebras System also provided telecommunications-
related services, such as data communication, sound and image transmission and
other value-added services throughout Brazil. On January 30, 1998, each of the
operating subsidiaries other than Embratel and Companhia Telefonica da Borda
do Campo--CTBC ("CTBC") spun off its cellular telephone operations into a
separate company.
In 1997, Telebras was the second largest company in Brazil as measured by
gross revenues of R$20.7 billion.
REGULATORY REFORM AND PRIVATIZATION
Beginning in 1995, the Federal Government undertook a comprehensive reform
of regulation of the telecommunications industry. In August 1995, the federal
Constitution was amended to permit the Federal Government to grant concessions
to private companies to provide telecommunications services. In July 1997, the
federal Congress adopted Law No. 9,472 of July 16, 1997, the Lei Geral de
Telecomunicacoes (the "Telecommunications Law"), which provided for the
establishment of a new regulatory framework, the introduction of competition
and the privatization of the Telebras System. The Telecommunications Law
established an independent regulatory agency called Agencia Nacional de
Telecomunicacoes ("Anatel"), which has begun to adopt a series of regulatory
enactments that implement the provisions of the Telecommunications Law
(together with the regulations, decrees, orders and plans issued by the
President of Brazil on telecommunications, the "Telecommunications
Regulations"). See "--Regulation of the Brazilian Telecommunications
Industry."
On May 22, 1998, in preparation for the privatization, the Telebras System
was restructured to form, in addition to Telebras, the twelve New Holding
Companies. Virtually all the assets and liabilities of Telebras were allocated
to the New Holding Companies, which, together with their respective
subsidiaries, now comprise (a) three regional fixed-line operators (including
the Company), (b) eight regional cellular operators and (c) one domestic and
international long-distance carrier. Prior to the Breakup of the Telebras
System, Embratel provided all interstate telephone service and the other
subsidiaries of Telebras provided fixed-line and cellular service in
1
<PAGE>
their respective territories, which, subject to limited exceptions,
corresponded to the separate Brazilian states. Following the Breakup, each of
the eight cellular operators provides cellular telephone service on Band A in
one of eight regions into which Brazil has been divided for purposes of
cellular telephone service and each of the three fixed-line operators provides
local fixed-line telephone service and intra-regional long-distance fixed-line
telephone service in one of three regions into which Brazil has been divided
for the purposes of fixed-line telephone service.
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive Shares of the twelve New
Holding Companies upon the distribution. The total consideration to be paid to
the Federal Government for the twelve New Holding Companies is R$22.1 billion.
In connection with this sale, the Federal Government assigned to the New
Controlling Shareholders substantially all its economic and voting rights with
respect to the New Holding Companies and, as a consequence, the New
Controlling Shareholders now control the New Holding Companies. Following the
distribution of the shares of the New Holding Companies, Telebras is expected
to be delisted from the NYSE and liquidated.
The New Controlling Shareholder of the Registrant is Tele Brasil Sul
Participacoes S.A. ("Tele Brasil Sul"), a company owned by Telefonica
Internacional S.A. (56.66%), Portugal Telecom S.A. (23.00%), Banco Bilbao
Vizcaya (7.00%), Iberdrola S.A. (7.00%) and RBS Participacoes S.A. (6.34%).
For a description of the business activities of the shareholders of Tele
Brasil Sul, see "Control of Registrant." Tele Brasil Sul agreed to pay R$5.78
billion for the Federal Government's stake in the Registrant, R$2.31 billion
of which was paid on August 3, 1998 and the remainder of which will be paid in
two equal installments over the next two years. The entire proceeds of the
sale of the Federal Government's stake in the Registrant will be retained by
the Federal Government.
On August 20, 1998, Brazil's Minister of Communications determined that
Telebras would be dissolved and liquidated. The Minister announced that
Telebras will prepare, within the next twelve months, a liquidation plan to be
submitted to a shareholders' meeting convened to approve the dissolution of
Telebras and its subsequent liquidation.
The adoption of the Telecommunications Law and the Telecommunications
Regulations has led, and the privatization of the Telebras System will lead,
to sweeping changes in the operating, regulatory and competitive environment
for Brazilian telecommunications. The changes include (a) the establishment of
an independent regulator and the development of comprehensive regulation of
the telecommunications sector, (b) the Breakup of Telebras, (c) the sale of a
controlling interest in the Registrant to one or more new investors and (d)
the introduction of competition in the provision of all telecommunications
services. All of these developments will materially affect the Company and the
other New Holding Companies, and the Company cannot predict the effects of
these changes on its business, financial condition, results of operations or
prospects. The extensive changes in the structure and regulation of the
Brazilian telecommunications industry must also be carefully considered in
reviewing historical information and in evaluating the future financial and
operating performance of the Company.
THE COMPANY
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. It owns 71.4% of the share capital (including 87.3% of the voting
stock) of Telesp, which is the principal provider of fixed-line public
telecommunications services in the Brazilian state of Sao Paulo. The
Registrant also owns, directly and through Telesp, 69.8% of the share capital
(including 86.7% of the voting stock) of CTBC, which provides local public
fixed-line telecommunications services in an area near the city of Sao Paulo.
See "Presentation of Information--Overview." The shares of Telesp and CTBC are
listed on the Brazilian stock exchanges. The minority interests in the Company
are held by pension funds sponsored by public companies, regional development
funds, mutual funds and individuals who obtained shares in the Company
pursuant to the prior system of "auto-financing" in which each new customer
was required to invest in shares of Telebras or its subsidiaries. For a
discussion of auto-financing see "--Rates--Local Services." In 1997, Telesp
generated 91%
2
<PAGE>
of the Company's net operating revenue and 91% of the Company's net income. In
1997, CTBC generated 9% of the Company's net operating revenue and 9% of the
Company's net income.
As a result of the Breakup of Telebras on May 22, 1998 and the privatization
of the New Holding Companies on July 29, 1998, the Company is in default under
substantially all of the credit agreements to which it is a party. The Company
is currently under negotiations with the appropriate creditors with respect to
the indebtedness in default. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources" and "Defaults upon Senior Securities."
Telesp was established in April 1973, as a successor to the formerly
foreign-controlled Companhia Telefonica Brasileira--CTB, which had been
purchased by the Federal Government. It also acquired a controlling interest
in CTBC in 1973. CTBC was founded in 1954 to provide telephone services in the
"ABC" region of the greater Sao Paulo metropolitan area, which consists
primarily of the municipalities of Santo Andre, Sao Bernardo do Campo and Sao
Caetano do Sul.
The Company provides public fixed-line telecommunications services pursuant
to concessions granted to Telesp and CTBC by the Federal Government (the
"Concessions"). Each Concession will expire on December 31, 2005 and may be
renewed for a further term of 20 years if the Company meets certain
obligations set forth in the Concessions. The Concessions may also be revoked
by Anatel prior to 2005 under certain circumstances. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." If the Company elects to renew a Concession, the Company will be
required to pay a biannual fee equal to 2% of its annual net revenue from the
provision of fixed-line public telecommunications services in the Concession
area for the prior year (excluding taxes and social contributions) during the
20-year renewal period. See "--Regulation of the Brazilian Telecommunications
Industry--Concessions and Licenses."
The Concessions authorize the Company to operate in concession areas
covering a region consisting of the entire state of Sao Paulo, excluding a
small area where two operators that were not part of the Telebras System
continue to operate independently (the "Region"). The portion of the state of
Sao Paulo that is excluded from the Region represents approximately 4% of
total lines in service and 2% of the population in the state. Within the
Region, the Company is currently the only supplier of local and intra-regional
fixed-line telecommunications services, but the Telecommunications Law and
Telecommunications Regulations contemplate the introduction of limited
competition following the privatization and full competition beginning after
December 31, 2001. See "--Competition."
The Company's Concessions have been granted under the Public Regime. For a
description of the Public Regime, see "--Regulation of the Brazilian
Telecommunications Industry--Concessions and Licenses." The Company, together
with Embratel and the two other regional fixed-line companies, is one of four
companies in Brazil operating under Public Regime Concessions. As an operator
under the Public Regime, the Company is subject to certain obligations,
principally concerning the continuous provision of service throughout the
Region ("universal service"), quality of service, and network expansion and
modernization. Anatel has the power, if certain of these obligations are not
met, to impose penalties including revocation of the Company's Concessions.
See "--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies."
The Registrant's headquarters are located at SCN-Quadra CN2, Lote F,
2(degrees) Andar, Sala 206, Brasilia-DF, 70710-500, Brazil, and its telephone
number is (011) (55) (61) 327-5500 or 327-5505.
THE STATE OF SAO PAULO
The state of Sao Paulo covers an area of 248,600 square kilometers,
representing 2.9% of the country's total area. Its population of approximately
34 million represents 21% of the total population of Brazil, and it has 60
metropolitan areas with populations in excess of 100,000 people. Per capita
income in the state of Sao Paulo is approximately US$8,000 per year and the
state generates approximately 35% of Brazil's gross domestic product. The
unemployment rate for the Sao Paulo metropolitan area is approximately 15%.
Approximately 35% of all domestic long-distance telecommunications traffic in
Brazil originates or terminates within the state of Sao Paulo.
3
<PAGE>
Set forth below is a map showing the location of the state of Sao Paulo
within Brazil.
[MAP OF BRAZIL]
The Company's business, financial condition, results of operations and
prospects depend in part on the performance of the Brazilian economy, in
general, and of the state of Sao Paulo, in particular. See "--Brazilian
Economic Environment."
CUSTOMER SERVICES
OVERVIEW
The services the Company provides and the composition of its revenues have
changed significantly as a result of the Telecommunications Law, the
Telecommunications Regulations and the Breakup and Privatization of the
Telebras System. The Company's current services include principally: (i) local
services, including installation charges, monthly subscription charges,
measured service and public telephones, (ii) intra-regional long-distance
service, (iii) data transmission, (iv) network services, including
interconnection and leasing of facilities, and (v) other services. The Company
does not sell, rent or otherwise provide telephone equipment such as handsets
or switchboards. Currently, the interconnection revenues the Company receives
include fees paid by Embratel, cellular companies and other telecommunications
companies for the use of the Company's network. Prior to April 1, 1998, the
Company's interconnection revenues did not include any revenues from Embratel.
4
<PAGE>
Rather than charging Embratel for interconnection, the Company retained a
fixed percentage of revenue from each interregional and international long-
distance call that originated on the Company's network. See "--Interregional
and International Service." The Company's revenues will be affected by
increased competition, the new regulatory environment and opportunities to
offer a broader range of services. See "--Competition" and "--Regulation of
the Brazilian Telecommunications Industry."
The following table breaks down the Company's revenue by type of service for
each of the years in the three-year period ended December 31, 1997. The
Company's tariffs for each category of service are described below under "--
Rates." Trends and events affecting the Company's operating revenue are
discussed under "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
---------------------
<S> <C> <C> <C>
1995 1996 1997
----- ------ ------
(IN MILLIONS OF
REAIS)
Local services........................................... 1,310 1,962 2,637
Intra-regional long-distance service..................... 1,097 1,206 1,032
Interregional long-distance service...................... 716 840 666
International long-distance service...................... 258 261 192
Data transmission........................................ 192 226 170
Network services......................................... 74 430 669
Other.................................................... 58 52 70
----- ------ ------
Total.................................................... 3,705 4,977 5,436
Taxes and discounts...................................... (961) (1,267) (1,349)
----- ------ ------
Net operating revenue.................................... 2,744 3,710 4,087
===== ====== ======
</TABLE>
LOCAL SERVICES
Local services include principally installation, monthly subscription,
measured service and public telephones. Measured service includes all calls
that originate and terminate within a single local area of the Region ("local
calls"). The Company is the sole provider of local services within the Region.
After the privatization of the Company, a new entrant will be granted a
license to provide local services in competition with the Company. See "--
Competition."
The Company owns and operates public telephones and telephone booths
throughout the Region. At December 31, 1997, the Company had 168,600 public
telephones, of which 54% could be operated with a prepaid debit card. The
Company had planned to replace all of its coin operated telephones with card
operated telephones in 1997 but was unable to carry out the plan because of
government limits on capital expenditures. See "--Capital Expenditures." The
targets proposed by Anatel require the Company to increase the number of
public telephones to 217,500 by 1999. See "--Network and Facilities--Network
Expansion" and "--Regulation of the Brazilian Telecommunications Industry--
Obligations of Telecommunications Companies--Network Expansion--General Plan
on Universal Service."
INTRA-REGIONAL LONG-DISTANCE SERVICE
Intra-regional long-distance service consists of all calls that originate
within one local area and terminate within another local area of the Region
(together with interregional long-distance service, "interurban" service).
Prior to the privatization of the Telebras System, the Company was the sole
provider of intra-regional long-distance service within the Region. After the
privatization of the Company, Embratel will also be authorized to provide
intra-regional long-distance service within the Region, and Anatel will grant
two new licenses for the provision of intra-regional long-distance service to
new entrants. See "--Competition."
5
<PAGE>
INTERREGIONAL AND INTERNATIONAL SERVICE
Interregional long-distance service consists of calls between a point
located within the Region and a point in Brazil outside the Region.
International long-distance service consists of calls between a point within
the Region and a point outside of Brazil. The Company is not itself authorized
to provide interregional long-distance or international service. Beginning in
2002, the Company may seek a license to provide interregional and
international long-distance service provided that it has met certain
obligations contained in the Concessions. See"--Competition" and "--Regulation
of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies."
Prior to April 1, 1998, Embratel and the operating subsidiaries of the
Telebras System divided the revenue from outgoing interregional and
international long-distance calls. The revenue sharing arrangement with
Embratel was designed to equalize the return of investment of the operating
subsidiaries. Under this system, the Company retained a fixed percentage of
the customer charges for outgoing interregional and international long-
distance calls and paid the balance to Embratel. The Company generally
received no revenue from incoming interregional or international long-distance
calls. The Company's percentage of revenues from outgoing calls was reset
annually effective as of April 1. Telesp's percentage was 70.48% from April
1996 to April 1997 and 53.94% from April 1997 to April 1998, while CTBC's
percentage was 87.59% and 90% for each such period, respectively. In the case
of interregional collect calls, the Company and the other regional operator
divided equally the portion of the customer charge not paid to Embratel.
Effective on April 1, 1998, the system of revenue-sharing was discontinued.
The Company's relationship with Embratel, or any other provider of
interregional and international services, is now governed by interconnection
agreements regulated by Anatel under which the providers of interregional and
international long-distance services will pay the Company fees for the use of
its network. See "--Regulation of the Brazilian Telecommunications Industry"
and "--Network Services." However, in order to soften the impact of the
discontinuation of the revenue sharing arrangement, the Company receives from
Embratel a supplemental per-minute rebate (Parcela Adicional de Transicao or
"PAT") that supplements the network usage charge. This supplemental per-minute
rebate from Embratel will be gradually phased out over the next three years.
Except for the revenue from Embratel that the Company receives during the
three year transitional period and revenue from network usage fees, the
Company no longer recognizes revenues from interregional and international
long-distance services. Embratel is now the only carrier of interregional and
international calls. However, the Telecommunications Regulations provide that
another long-distance carrier will be licensed following the privatization of
the Telebras System and, beginning in 2002 at the earliest, the Company may be
permitted to provide such long-distance services. See "--Competition."
NETWORK SERVICES
The Company provides access to its network to other telecommunications
companies and leases certain network facilities to other telecommunications
and non-telecommunications companies as part of its network services business.
The Company increasingly provides interconnection services to other
telecommunications service providers as a result of the spin-off of Telesp's
cellular business, the Breakup of the Telebras System and the advent of
competition. Cellular companies, Embratel and certain licensees that operate
telecommunications networks interconnect with the Company's network in order
to receive calls that originate on the Company's network, to deliver calls
that terminate on the Company's network and to transport over the Company's
network calls that originate and terminate outside of the Company's network.
Interconnection revenues consist of fees collected by the Company for such use
of its network by other telecommunications network operators (network usage
fees) and for providing a physical connection to the network. See "--Rates--
Network Services." Since July 1996, following the introduction of competition
in cellular services, the terms of interconnection between fixed-line and
cellular operators have been subject to regulation. See "--Regulation of the
Brazilian Telecommunications Industry--Rate Regulation--Network Usage
Charges."
6
<PAGE>
Currently, the Company provides interconnection services to two cellular
providers, including the company it spun off on January 30, 1998, and some
operators of trunking services. Effective in April 1998, the Company also
entered into an interconnection agreement with Embratel under which Embratel
pays network usage fees to the Company for the use of its network. See "--
Interregional and International Service." The Company expects to be a net
recipient of fees under this agreement in the near future because the Company
is not permitted to provide interregional or international long-distance
service until 2002 at the earliest. See "--Competition." There can be no
assurance that the interconnection agreement with Embratel will not result in
lower revenue for carrying interregional and international long distance calls
than under the prior regime.
The terms of interconnection, particularly pricing and technical
requirements, may affect the Company's results of operations, its competitive
environment and its capital expenditure policies. Under the current regulatory
framework, all telecommunications service providers must provide
interconnection services on a non-discriminatory basis. Subject to certain
requirements, providers are free to negotiate the terms of interconnection
but, in the event the parties fail to reach an agreement, Anatel will
establish the terms of interconnection. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Interconnection."
The Company also leases facilities. Other telecommunications companies,
particularly cellular companies, lease trunk lines from the Company for use
within their stand-alone networks and large corporate customers lease lines
from the Company for use within private networks connecting different internal
corporate sites.
DATA TRANSMISSION SERVICE
The Company provides low- and high-speed data transmission services through
private leased circuits, public network infrastructure exchanges and access to
Embratel's data transmission network. The Company has provided data
transmission services since October 1991. At December 31, 1997, the Company
had more than 80,000 accesses for data transmission, voice and image
applications. The Company invested in data transmission capacity in response
to the growing demand in Brazil for services that require high velocity
dedicated digital circuits, such as data, image and text transmission,
corporate networking and video conferencing. The Company is implementing
30,000 access gates (17,000 dedicated and 13,000 switched) to provide
additional services in data transmission, including SPPAC, SPDADOS, SPFAST and
SPVIP.
SPPAC is a line of services providing the user multiple access databases,
home banking services, and internet providers. SPDADOS is a line of digital
services dedicated to voice applications, data and image interlinking to
computers, corporate video conferencing, CAD/CAM software applications, and
other uses characterized by high velocity communication. SPFAST is a line of
services based on the Frame Relay protocol directed to applications that
require high speed and short response time. SPVIP is the provision of
telecommunications services tailored to the specific needs of corporate
customers and may include such services as interconnection of data processing
centers, local networks, digital PBXs and corporate video conferencing.
OTHER SERVICES
The Company provides a variety of other telecommunications services that
extend beyond basic telephone service. The Company also provides interactive
banking services, electronic mail and other similar services.
7
<PAGE>
QUALITY OF SERVICE
Since the beginning of 1990, the quality of certain telecommunications
services provided by the Company has been improved through network upgrading
and the addition of automatic operational support systems. The following table
gives certain basic measures of the quality of telecommunications services for
each year in the five-year period ended December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Repair requests per 100 installed access lines....... 2.1 1.9 2.3 2.6 2.8
Response rate to repair requests (percentage)(1)..... 93.7 92.9 84.6 86.0 81.1
Rate of obtaining dialing tone within 3 seconds (per-
centage)............................................ 98.2 98.9 99.0 99.1 99.0
Call completion rate (direct-dialed domestic long-
distance calls) (percentage) ....................... 50.7 52.7 54.1 54.5 56.5
</TABLE>
- --------
(1) Response within 24 hours after request was made.
The Company is required under the Telecommunications Regulations to meet
certain quality of service targets, including call completion rates, repair
requests and response rate to such requests, operator response periods and
other measures of service quality. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Quality of Service--General Plan on Quality." The Company has identified the
quality of service targets that the Company expects will be most difficult to
meet, those the Company expects to meet with medium difficulty and those the
Company expects to meet with relative ease. The targets the Company expects
will be most difficult to meet are maximum public telephone repair requests
and targeted response times to nonresidential and public telephone repair
requests. Currently, the Company receives .29 public telephone repair requests
per month per line. The Company is obligated by year end 1999 to reduce repair
requests to .15 per line. Currently, the Company responds within eight hours
to 47% of nonresidential repair requests and 44% of public telephone repair
requests. The Company is obligated by year end 1999 to respond within eight
hours to 95% of nonresidential and public telephone repair requests. In order
to meet these targets, the Company is developing software that will enable the
Company to test the functioning of public telephones from a centralized
automatic supervision center. The Company is also increasing maintenance
operations in order to repair public telephones at night. All other targets
the Company expects to meet with medium difficulty except for the target for
obtaining a dial tone within three seconds which the Company has already met.
RATES
Rates for telecommunications services provided by the Company are subject to
comprehensive regulation. See "--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." Since the relative
stabilization of the Brazilian economy in mid-1994, there have been two major
changes in rates for local and long-distance services. Effective in January
1996, rates for all services were increased, primarily to compensate for
accumulated effects of inflation. Effective in May 1997, the rate structure
was modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription, and lower charges for intra-
regional, interregional and international long-distance services. Monthly
subscription charges, for example, were increased by 270% for residential
customers and 59% for commercial customers. The Company believes that monthly
subscription charges are now generally in line with such charges in other
countries.
LOCAL SERVICES
The Company's revenue from local services consists principally of activation
and installation charges, monthly subscription charges, measured service
charges and public telephone charges.
Users of measured service, both residential and nonresidential, pay for
local calls depending on usage. Usage is measured in pulses. Pulses occur
system-wide every four minutes for most local calls and every sixty
8
<PAGE>
seconds for local calls made between certain municipalities. These system-wide
pulses are recorded independently of when individual calls are actually made.
In addition to system-wide pulses, the system records one pulse for every call
when the call is connected. After the first pulse, only system-wide pulses are
used in determining the charge for a call. As a result, the time between the
first pulse and the second (system-wide) pulse may vary. For example, for a
call being charged using four-minute pulse increments, the time between the
first pulse and the second (system-wide) pulse may vary between one second and
four minutes.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from 2:00 p.m. to
midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call. Each customer receives a total of
90 free pulses per month. Approximately 91.5% of the Company's customers use
over 90 pulses per month. Measured service charges are the same for all
customers.
Since May 1997, the monthly subscription charge in nominal terms (including
taxes) has been R$13.82 for residential customers, R$20.73 for commercial
customers and R$27.64 for users of PBX systems and the price of one pulse
(including taxes) has been R$0.08. The following table illustrates changes in
subscription charges and measured service charges for local telephone service
for each year in the three-year period ended December 31, 1997 in constant
reais of December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN REAIS)
<S> <C> <C> <C>
Average rates for local telephone service(1):
Monthly subscription:
Residential......................................... 0.82 3.00 7.78
Commercial.......................................... 7.28 10.46 13.50
Measured service (per local pulse).................... 0.025 0.038 0.054
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes.
Prior to May 1997, under a system called "auto-financing," each new customer
was required to invest in shares of Telebras or of its subsidiaries. The
amount to be invested varied from time to time but was very substantial. In
1996, for example, the required investment for a new line was R$1,117.63.
Auto-financing was phased out in 1997, and since July 1997 the installation
charge, which was initially R$300, has been reduced to R$80 in October 1997
and to R$50 in March 1998. The Company also charges an activation fee of R$48
when a customer changes addresses.
INTRA-REGIONAL LONG-DISTANCE SERVICE
Rates for intra-regional long-distance calls are computed on the basis of
the time and day, duration and distance of a call and use of special services,
such as operator assistance. Some intra-regional calls made within the same
area code may also be measured by pulses. Rates for domestic long-distance
(whether intra-regional or interregional) are uniform throughout Brazil. See
"--Regulation of the Brazilian Telecommunications Industry--Rate Regulation."
The following table illustrates changes in the Company's domestic long-
distance rates for the periods indicated in constant reais of December 31,
1997 purchasing power.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(IN R$)
<S> <C> <C> <C> <C> <C>
Domestic long-distance rates(1):
0 to 50 km........................................... 0.79 0.46 0.46 0.42 0.32
50 to 100 km......................................... 1.32 0.78 0.76 0.70 0.54
100 to 300 km........................................ 1.98 1.18 1.16 1.07 0.81
over 300 km.......................................... 2.65 1.57 1.53 1.40 1.08
</TABLE>
- --------
(1) Rates for a domestic long-distance call, three minutes in duration between
the hours of 9 a.m. and 12 p.m. and 2 p.m. and 6 p.m. (peak hours) on
weekdays, net of value-added taxes.
9
<PAGE>
NETWORK SERVICES
The Company's revenue from network services consists primarily of two basic
categories: payments from other providers on a per-minute basis to complete
calls using the Company's network and payments from other providers on a
contractual basis to use part of the Company's network. On a per-minute basis,
other providers pay the Company a network usage charge to complete a call on
the Company's network. The network usage charge varies depending on whether
the provider uses the Company's local or long-distance network. Similarly, the
Company pays other fixed-line providers a network usage charge to complete a
call on another fixed-line network and the Company pays cellular providers a
network usage charge to complete a call on a cellular network.
Cellular telephone service in Brazil, unlike in North America, is offered on
a "calling party pays" basis. Under the policy of a calling party pays, a
cellular service subscriber generally pays cellular usage charges only for
calls made by the cellular subscriber and not for calls received. Calls
received by a cellular subscriber are paid for by the party that places the
call in accordance with a rate based on cellular per minute charges. For
example, a fixed-line customer pays a rate based on cellular per minute
charges for calls made to a cellular subscriber. The cellular base rate per
minute charges are generally VC1, for calls within the locality, VC2, for
calls outside the cellular subscriber's registration area, and VC3, for calls
outside the concession region in which the registration area is located. The
Company charges its fixed-line customers per minute charges based on either
VC1, VC2, or VC3 rates when a fixed-line customer calls a cellular subscriber.
In turn, the Company pays the cellular service provider the mobile network
usage charge.
For calls made by the Company's customers that terminate on the networks of
Band B cellular operators, the network usage charges the Company must pay to
the Band B operator to complete such calls exceed the retail measured usage
charges the Company is permitted to collect from its customers. This results
in a loss for certain calls made by the Company's customers that terminate on
a Band B network, particularly for calls made during reduced-rate evening
hours. The Company has requested that Anatel either increase the Company's
network usage rates or decrease the cellular providers' cellular network usage
rates. Anatel has not yet provided a response to the Company's request for
rate adjustments and there can be no assurance that Anatel will adjust network
usage rates in a way that will be favorable for the Company. For a discussion
of the Company's payments to cellular provisions see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations for the years ended December 31, 1995, 1996 and 1997--Cost of
services--Services."
The Company's revenue from network services also includes payments from
other telecommunications providers arranged on a contractual basis to use part
of the Company's network. Other providers, such as providers of trunking and
paging services, may use the Company's network to connect a central switching
station to the Company's network. Some cellular providers use the Company's
network to connect cellular central switching stations to the cellular radio
base stations. The Company also leases transmission lines, certain
infrastructure and other equipment to other providers of telecommunications
services.
The table below sets forth the average rates charged by the Company for
network services charged on a per-minute basis in the three year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN REAIS)
<S> <C> <C> <C>
Network usage rate (local)(1)......................... 0.031 0.031 0.036
Network usage rate (long-distance)(1)................. 0.062 0.062 0.066
Per minute charges for calls made to the cellular
network:
VC1................................................. 0.37 0.37 0.37
VC2................................................. 0.80 0.80 0.80
VC3................................................. 0.91 0.91 0.91
</TABLE>
- --------
(1) Net of taxes.
10
<PAGE>
DATA TRANSMISSION
The majority of revenue from data transmission services is generated by
monthly line rental charges for private leased circuits. The balance consists
mainly of nominal charges for access to the data transmission network and
measured charges based on the amount of data transmitted. Effective in May
1997, line rental charges for private leased circuits were reduced by 42%. The
following table illustrates the Company's average monthly line rental charges
for private leased circuits service for each year in the three-year period
ended December 31, 1997 in constant reais of December 31, 1997 purchasing
power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
--------- --------- ---------
(IN REAIS)
<S> <C> <C> <C>
Average rates for monthly line rental per leased
circuit: (1)
9.6 kbits/second capacity..................... 3,236.94 2,427.69 1,011.92
64 kbits/second capacity...................... 9,178.15 5,940.72 2,335.00
2 Mbits/second capacity....................... 58,829.47 45,844.62 29,088.43
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes, assuming a
transmission distance between 300 and 500 kilometers.
TAXES ON TELECOMMUNICATIONS SERVICES
The cost of all telecommunications services to the customer includes a
variety of taxes. The Company deducts the amount of such taxes to present net
operating revenue. The principal tax is a state value-added tax, the Imposto
sobre Circulacao de Mercadorias e Servicos ("ICMS"), which the Brazilian
states impose at varying rates on revenues from the provision of
telecommunications services. The rate in the state of Sao Paulo is 25% for
domestic telecommunications services.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) new taxes may not be applied
retroactively.
At present, the Company has not sought to challenge the taxing authorities'
position with respect to application of the ICMS tax to activation fees. If
the 25% ICMS tax were applied retroactively to activation fees earned by the
Company during the last five years, it would give rise to a maximum liability
estimated at R$186.9 million. Management does not believe that the payment of
retroactive ICMS taxes is probable and, therefore, no provision for loss with
respect to retroactive application of the ICMS has been made or is expected to
be made in the Company's consolidated financial statements. Management does
not believe that application of the ICMS tax on a prospective basis will have
a material impact on the Company's results of operations.
Other taxes on operating revenues include two federal social contribution
taxes, the Programa de Assistencia aos Servidores de Empresas Publicas
("PASEP") (0.65%) and the Contribuicao para Financiamento da Seguridade Social
("COFINS") (2.0%). The average rate of all such taxes, as a percentage of the
Company's gross operating revenues, was 24% in 1997.
11
<PAGE>
NETWORK AND FACILITIES
GENERAL
The Company's network consists of installed lines and exchanges, a network
of access lines connecting customers to exchanges, and long-distance related
systems. At December 31, 1997, the Company's regional telephone network
included approximately 6.0 million installed lines, of which 5.5 million were
lines in service. Of the access lines in service at that time, 68.1% were
residential lines, 29.2% were commercial lines and 2.7% were public telephone
lines. Intra-regional long-distance transmission is provided by a microwave
network and by fiber optic cable.
The following table gives certain basic measures of the development of the
Company's network service for each year in the five-year period ended December
31, 1997.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Installed access lines (millions)............... 4.3 4.5 4.9 5.4 6.0
Access lines in service (millions).............. 4.1 4.3 4.5 5.1 5.5
Average access lines in service (millions)...... 4.1 4.1 4.4 4.8 5.3
Lines in service per 100 inhabitants............ 12.8 13.1 13.7 15.2 16.5
Percentage of installed access lines connected
to digital exchanges........................... 26.2 33.3 43.4 51.1 57.6
Employees per 1,000 access lines installed...... 6.2 5.8 5.1 4.3 4.0
Number of public telephones (thousands)......... 102.0 120.6 126.6 146.7 168.6
Local call pulses (billions).................... 21.5 22.2 23.3 24.3 23.5
Domestic long-distance call minutes (billions).. 5.3 6.3 7.9 9.0 9.9
International call minutes (millions)........... 79.3 94.5 145.5 165.5 202.6
</TABLE>
The Company believes that the unmet demand for fixed-line telecommunications
services in the Region is substantial. At December 31, 1997, 37% of the
households and 68% of the businesses in the Region had local telephone
service. Prior to the privatization, growth of lines in service was restricted
by government limits on capital expenditures. See "--Capital Expenditures." In
1997, the Company experienced a significant increase in applications for new
lines because the cost to the customer of installing new lines significantly
decreased following the elimination of auto-financing. See "--Rates--Local
Services." The customer waiting period for the installation of a new line
varies significantly depending on the capacity of the switching center that
serves the locality.
The Company began to install digital exchanges in 1982 and fiber optic cable
in 1984. Compared to the older analog technology, digital systems improve the
quality and efficiency of the network, accommodate higher traffic levels,
require less maintenance and permit the Company to offer a broad range of
value added services simultaneously on the same network, such as voice, text
and data applications. Optical fiber provides greater transmission capacity
and significantly reduces the fading of signals, and requires less frequent
amplification, thereby reducing the cost of providing service and increasing
traffic capacity and network reliability. Beginning in 1997, all new lines
installed by the Company were connected to digital exchanges and, during 1997,
14.7% of existing analog lines were converted to digital lines. At December
31, 1997, 57.6% of all installed lines were connected to digital exchanges. By
year end 1997, the Company installed 198,217 kilometers of fiber optic cable.
By the end of 2005, the Company plans to have replaced almost all of its
analog exchanges with digital exchanges.
The Company's network strategy is to develop an integrated broadband network
supporting all types of telecommunications services and multimedia, data and
image applications. It is incorporating new digital-based technologies in its
network with a view to providing integrated services. It is also developing
plans to install ATM-Asynchronous Transfer Mode technology network and
transmission platforms for high-speed switched services that will accommodate
image transmission. Beginning this year, it plans to establish an ISDN-
Integrated Services Digital Network that will provide high-quality, high-speed
capacity at competitive prices to residential
12
<PAGE>
and small business customers, which are increasingly demanding such services.
The Company is also developing a digital-based systems architecture for the
basic local and regional network with a 2.5 Gbit SDH-Synchronous Digital
Hierarchy transmission network linking transit and tandem switches that will
improve service delivery by placing the digital accesses as close as possible
to the user.
NETWORK EXPANSION
The Company is required under the Telecommunications Regulations to meet
certain targets regarding network expansion and modernization. See "--
Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies--Network Expansion--General Plan on Universal
Service." The Company has identified the targets that the Company expects will
be most difficult to meet, those the Company expects to meet with medium
difficulty and those the Company expects to meet with relative ease. The
targets the Company expects will be most difficult to meet are maximum waiting
periods for the installation of a line, network digitalization and public
telephone availability. The Company is obligated to reduce the maximum waiting
time for installation of a line by year end 2001 to four weeks. Currently, the
average waiting time is 76 weeks, although the Company believes that a
significant portion of the persons on its waiting list are seeking to obtain a
phone line for resale on the secondary market rather than for personal use.
The Company believes that prior to privatization, the Company would not have
been able to comply with this target. However, following privatization, demand
will be met more readily as competitors enter the market and the Company
expands its own network without government-imposed restrictions on
investments. See "--Competition" and "--Capital Expenditures." The Company is
obligated by year end 1999 to achieve a 75% level of digital penetration.
Currently, the Company's network is 66% digital. Through investment in its
network, the Company plans to exceed the 75% digital penetration target in
1999. The Company is obligated by year end 1999 to have 50% of public
telephones available 24 hours per day with local and domestic long-distance
direct-dial capability and 25% of such phones with international long-distance
direct-dial capability. Currently, the Company has 46% of such phones
available with local and domestic long-distance direct-dial capability and
0.05% with international long-distance direct-dial capability. The Company's
future plans for capital expenditures include development of the public
telephone network in order to meet the Anatel targets. The Company expects to
meet with medium difficulty the targets requiring increases in total number of
lines in service and general increases in public telephones. All other targets
the Company expects to meet with relative ease.
BILLING AND ADMINISTRATION
The Company bills its customers for all calls made by its customers. The
Company receives network usage fees when calls from cellular carriers or other
fixed-line carriers terminate calls on its network and conversely, the Company
must pay network usage fees when calls from its customers terminate on the
network of a cellular carrier or one of the other fixed-line carriers. See "--
Rates--Network Services." After the collection cycle is over, the Company, the
cellular carriers and the other fixed-line carriers jointly reconcile the
amounts collected from customers against the amounts due to each carrier and
pay the net amounts outstanding to the appropriate parties. For international
and domestic long distance calls, the Company charges Embratel a fee for the
use of its local network and forwards the amount collected from its customers
for such calls to Embratel.
The Company sends each customer a monthly telephone bill covering all the
services provided during the prior period. Customers are grouped in fourteen
billing cycles based on the date the bill is issued. The telephone bill
separately itemizes long distance calls, calls made on a cellular network,
0800 and 0900 services and other services such as call waiting, voice mail and
call forwarding. Customer payments are effected under agreements with various
banks, either by debiting the customer's checking account or by direct payment
to a bank. The method of payment is at the option of each customer.
In 1997, the Company blocked the service of approximately 1.7 million lines,
and approximately 94.8% of such lines were unblocked following payment of the
overdue amounts. The Company charges interest at a rate of 1% per month plus a
one-time late charge of 2% of the total amount outstanding.
13
<PAGE>
At December 31, 1997, 7.8% of all receivables were outstanding between 30
and 90 days and 4.8% of all receivables were outstanding for more than 90
days. Under previous regulations, the Company was not permitted to disconnect
a customer until a receivable was outstanding for over 90 days. The Company's
Concession agreements now authorize the Company to disconnect a customer after
30 days. The Company's future disconnection policy will depend on factors such
as the level of unmet demand, the level of competition and regulations
governing disconnection. The Company may take future measures that result in a
higher level of late payments or defaults. For a discussion of provisions for
past due accounts, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations for the years ended
December 31, 1995, 1996 and 1997--Operating expenses--Selling expense."
COMPETITION
Since 1995, Brazil has adopted sweeping regulatory changes intended to
foster competition in the provision of telecommunications services. See "--
Background--Regulatory Reform and Privatization." Under the Telecommunications
Law and Telecommunications Regulations, Anatel is required, promptly after the
privatization, to open the markets to competition for local, intra-regional
long-distance, interregional long-distance and international long-distance
services by granting licenses to new entrants. Anatel is required to authorize
three new entrants to provide local telephone service and intra-regional long-
distance telephone service, with each of the three new entrants receiving two
licenses to provide such services in a single fixed-line Region, in addition
to authorizing one new entrant to provide intra-regional, interregional and
international telephone long-distance service by granting licenses to provide
such services throughout Brazil. These licenses will be issued in the Private
Regime and, as a result, the licensees will not be subject to the same
obligations to which concessionaires operating in the Public Regime are
subject. See "--Regulation of the Brazilian Telecommunications Industry--
Concessions and Licenses." In addition, Anatel is required to authorize
Embratel to provide full intra-regional long-distance service, including any
calls between local calling areas. Beginning in 2002, Anatel may grant an
unlimited number of additional licenses for the provision of local,
intraregional long-distance, interregional long-distance and international
long-distance services. See "--Regulation of the Brazilian Telecommunications
Industry--Concessions and Licenses."
The Company is currently the exclusive provider of local service in the
Region, but the new operator to be authorized by Anatel will compete with the
Company in the provision of local service. The Company is also currently the
exclusive provider of intra-regional long-distance service in the Region, but
following the privatization, Embratel will be authorized to compete with the
Company in the provision of intra-regional long-distance service in the
Region. In addition, the Company will face competition in intra-regional long-
distance from two new entrants. Beginning in 2002, the Company may face an
unlimited number of competitors in local and intra-regional long-distance, and
it may itself seek a license to provide interregional and international long-
distance service provided that it has met certain obligations contained in the
Concession. See "--Regulation of the Brazilian Telecommunications Industry--
Obligations of Telecommunications Companies."
The Company expects that Embratel will enter the intra-regional long-
distance business and begin to compete directly with the Company, although it
cannot predict the scope of Embratel's activities or the effect of competition
from Embratel. Embratel, the former long-distance carrier of the Telebras
System, is a potentially powerful competitor, with an extensive transmission
network, extensive experience and financial resources. The Company's fixed-
line services are also subject to competition from providers of cellular
telephone service. There are currently three cellular telephone service
operators in the Region: Telesp Cellular, which was spun off from the Company
in January 1998, BCP (a consortium including Bell South Corporation of the US,
the media group OESP, Safra Bank and Splice) and Tess (a consortium including
Telia of Sweden, two Brazilian construction firms and Unibanco).
The exact identity of other new entrants, the scope of increased competition
and any adverse effects on the Company's results and market share will depend
on a variety of factors that cannot now be assessed with precision and that
are beyond the Company's control. Among such factors are the business
strategies and capabilities of potential competitors, prevailing market
conditions at the time increased competition is permitted,
14
<PAGE>
the regulations applicable to new entrants and the Company, and the
effectiveness of the Company's efforts to prepare for increased competition.
One or more new competitors may have technical or financial resources greater
than those of the Company. There can be no assurance that the entry of new
competitors will not have a material adverse effect on the Company's business,
financial condition, results of operations or prospects.
The Company is subject to comprehensive regulations that limit its ability
to set tariffs for its various services and that may limit its ability to
engage in activities that are considered to be anti-competitive. Such
regulations may limit the Company's ability to confront competition. See "--
Regulation of the Brazilian Telecommunications Industry."
EMPLOYEES
As of February 28, 1998, the Company had 22,728 employees. All of the
Company's employees are employed on a full time basis, grouped according to
the following functions: 0.7% in corporate management, 1% in marketing, 8% in
plant expansion and modernization, 43% in plant operation and maintenance, 24%
in client services, 3% in human resources, 4% in budget and finance, 3% in
supplies, 4% in information services, 4% in administrative support and 5% in
general administration.
Approximately 54.3% of all employees are members of state labor unions
associated either with the Federacao Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel") or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). Some employees in particular job
categories are affiliated with other unions specific to such categories. Each
operating subsidiary of the Company negotiates a new collective labor
agreement every year with the local union. These negotiations are carried out
with the supervision and guidance of the Company, on one side, and Fenattel or
Fittel, on the other. The collective agreements currently in force expire on
November 30, 1998. The Company's management considers the relations of the
Company with its work force to be satisfactory. The Company has never
experienced a work stoppage that had a material effect on its operations.
The Company participates in a pension fund established by Telebras, Fundacao
de Seguridade Social ("Sistel"), the primary purpose of which is to supplement
government-provided retirement benefits. The Company participates in Sistel
and makes monthly contributions to Sistel currently equal, on average, to
13.5% of the total salaries of all employees who are Sistel members. Each
employee member also makes a monthly contribution to Sistel based on age and
salary (currently around 7.4% of their salaries). Members of Sistel qualify
for full pension benefits after reaching age 57 provided they have been
members of Sistel for at least ten uninterrupted years and have been
affiliated with the social security system during at least 35 years. Sistel
operates independently from the Company and Telebras, and its assets and
liabilities are fully segregated from those of the Company and Telebras. See
Note 24 to the Consolidated Financial Statements. Employees of the Company at
the time of the privatization have the right to maintain their rights and
benefits in Sistel in accordance with the terms in place at that time.
RESEARCH AND DEVELOPMENT
Until the Breakup of Telebras, the Company and the other companies of the
Telebras System were required to contribute to the research and development
center operated by Telebras (Centro de Pesquisa e Desenvolvimento da
Telebras--CPqD or the "Center") and also conducted some of their own
independent research and development. The Company's aggregate expenditures on
research and development were R$26.0 million, R$27.7 million and R$23.6
million for 1995, 1996 and 1997, respectively.
Following the Breakup of Telebras, the Center will become a private
independently administered non-profit foundation financed with resources from
the public and private sector and will continue to develop telecommunications
technology. Pursuant to an agreement signed in May 1998 between Telebras and
Telesp, the Company is obligated to contribute R$98.5 million to the Center
during a three-year period ending May 2001. During the effectiveness of this
agreement, the Company has access to telecommunications software developed
15
<PAGE>
by the Center and other technological services provided by the Center such as
equipment testing and consulting and training services. It is possible that
the Center will also provide such services to third parties on a fee-for-
service basis. The Company may request additional technological support from
the Center than contemplated in the agreement by contributing additional funds
to the Center.
The Company conducts independent research and development in areas of
telecommunications services but does not independently develop new
telecommunications hardware. The Company primarily depends on manufacturers of
telecommunications products for the development of new hardware.
CAPITAL EXPENDITURES
The primary focus of the Company's capital expenditure program has been the
expansion, modernization and digitalization of the network. For the future,
the Company expects to emphasize the development of the integrated broadband
network, as described under "--Network and Facilities."
Prior to the Breakup of Telebras, capital expenditures were planned and
allocated on a system-wide basis and were subject to approval by the Ministry
of Communications. In addition, the budget for capital expenditures of the
Telebras System was included in the annual budget of the Federal Government
and had to be approved by the federal Congress. In 1995, the Federal
Government instituted a broad investment program for public and private
businesses in the communications and postal sectors for the years 1995 through
2003 (Programa de Recuperacao e Expansao dos Sistemas de Telecomunicacoes e
Postal--PASTE or "PASTE"). The Telebras System was required to conform its
annual capital expenditure budget to the guidelines set by PASTE. The
companies that comprised the Telebras System were further required to comply
with public bidding processes prior to hiring third party contractors.
Since the Breakup and privatization of Telebras, the Company's capital
expenditures have not been subject to prior government approval nor
government-imposed spending limits nor public bidding processes. The Company
is now permitted to determine its own capital expenditure budget, subject to
compliance with certain obligations to expand services under the Concessions.
See "--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies." In addition, the financing of capital
expenditures is no longer carried out on a system-wide basis, and the Company
is required to obtain its own financing. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
The 1998 annual capital expenditure budget for the Telebras System includes
capital expenditures of the Company. The Company anticipates that capital
expenditures for the first eight months of 1998 will be R$1,710 million, which
is expected to be funded with internally generated funds from operations. The
Company expects, however, that as a result of the privatization, all capital
expenditures will be subject to revision by management and the new controlling
shareholders of the Company.
16
<PAGE>
The following table sets forth, in constant reais of December 31, 1997
purchasing power, the Company's capital expenditures for each year in the
three-year period ended December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN MILLIONS OF REAIS)
<S> <C> <C> <C>
Operational investments (1)............................. 246.2 253.7 148.5
Telephone equipment:
Exchanges........................................... 241.7 309.1 364.7
Transmission........................................ 173.5 87.9 122.2
Infrastructure...................................... 64.3 79.0 239.5
External network.................................... 381.5 452.3 496.2
Other............................................... 95.7 91.2 58.6
Data transmission equipment............................. 45.7 50.1 49.9
------- ------- -------
Total capital expenditures(2)........................... 1,248.6 1,323.3 1,479.6
======= ======= =======
</TABLE>
- --------
(1) Operational investments include investments to replace plant equipment and
other fixed assets generally without altering the capacity of the asset
replaced and certain investments in operational and technical support such
as telecommunications management network systems.
(2) The records on which the figures in the above table are based do not
include capitalized interest nor, for 1995, community expansion plan
investments (See Note 26 to the Consolidated Financial Statements).
Accordingly, Management has included these items within the identified
expenditure categories on an estimated basis.
REGULATION OF THE BRAZILIAN TELECOMMUNICATIONS INDUSTRY
GENERAL
The Company's business, including the services it may provide and the rates
it charges for telecommunications services, is regulated by Anatel pursuant to
the Telecommunications Law, the regulations, decrees, orders and plans issued
thereunder and the Concessions granting the Company the right to provide
certain telecommunications services, subject to certain obligations contained
in the Concessions (the "List of Obligations").
BACKGROUND
From 1962 until 1967, the Brazilian telecommunications sector was regulated
by the Conselho Nacional de Telecomunicacoes (the "National Council of
Telecommunications"), and from 1967 until 1997 by the Ministry of
Communications, pursuant to Law No. 4,117 of August 27, 1962, as well as
certain regulations issued pursuant thereto from 1962 to 1996.
In August 1995, the Brazilian Congress amended the Brazilian Constitution to
allow the restructuring of the telecommunications sector. On July 19, 1996,
the Congress passed Law 9,295, the Lei Minima (the "Minimum Law"). The Minimum
Law began the process of opening up the cellular market to competition. The
Minimum Law was largely replaced by the Telecommunications Law, although
current cellular concessions for the former Telebras companies ("Band A") and
the private companies that were authorized to compete with the Band A
companies ("Band B") contain certain provisions derived from the Minimum Law.
In July 1997, the Congress passed the Telecommunications Law, which replaced
Law 4,117 and became the main basis for regulation of the telecommunications
sector, except for regulation of broadcasting, which was not addressed by the
Telecommunications Law.
REGULATORY AGENCY--ANATEL
The Telecommunications Law provides a framework for telecommunications
regulation. Article 8 of the Telecommunications Law established Anatel to
develop regulations and to enforce such regulations. The specific functions of
Anatel were set forth by the President of Brazil in Decree No. 2338 of October
7, 1997, the
17
<PAGE>
Regulamento da Agencia Nacional de Telecomunicacoes (the "Anatel Decree").
Pursuant to the Telecommunications Law and the Anatel Decree, Anatel replaces
the Ministry of Communications as the regulatory agency for the
telecommunications sector. Anatel, unlike the Ministry of Communications, is
an independent regulatory agency. Anatel is administratively independent,
financially autonomous and not hierarchically subordinated to any organ of the
Brazilian Government, including the Ministry of Communications, in the area of
telecommunications regulation. While independent, Anatel does maintain a close
working relationship with the Ministry of Communications and informs the
Ministry of its activities. Article 19, Section XXIX of the Telecommunications
Law requires Anatel to submit an annual report summarizing its activities to
the Ministry of Communications.
Anatel is managed by a five-member Conselho Diretor ("Board of Directors"),
headed by an executive president. The directors of Anatel are nominated by the
President of Brazil, subject to approval by the Senate. Each director serves
for a single fixed term of 5 years; directors may not be reappointed. In order
further to ensure Anatel's independence, the first directors have been
appointed for different terms, from 3 to 7 years, so that only one director's
mandate will expire per year, ensuring a staggered appointment of directors in
the future. The directors may not exercise any other professional, business
(other than university professor), union or political function, nor may they
hold a significant interest, whether direct or indirect, in any company
related to telecommunications.
Anatel is financed through the Fundo de Fiscalizacao das Telecomunicacoes
("Fistel"). Fistel is a fund administered by Anatel and its funds are
currently the sole source of financing for Anatel's activities. Fistel
receives the proceeds of, among other things, a tax imposed on concessionaires
and fees charged for licenses and concessions.
Any proposed regulation of Anatel is subject to a period of public comment,
including public hearings. Anatel's actions may ultimately be challenged in
Brazilian courts.
CONCESSIONS AND LICENSES
Companies wishing to offer telecommunications services to consumers are
required to apply to Anatel for a concession or license. Concessions and
licenses are granted for services in the public regime ("Public Regime") and
services in the private regime ("Private Regime"). The Public Regime is
differentiated from the Private Regime primarily by the obligations imposed on
the companies in the Public Regime rather than the type of services offered by
those companies. There are only four companies in the Public Regime: Embratel
and the three regional fixed-line companies. All other telecommunications
companies, including other companies providing the same telecommunications
services as the four companies in the Public Regime, operate in the Private
Regime.
Fixed-line Services--Public Regime. There are four providers of services in
the Public Regime: Embratel and the three regional fixed-line companies. These
four companies are the primary providers of the following fixed-line services
to the general public: local, intra-regional long-distance, interregional
long-distance and international long-distance. Each of these four companies
holds concessions, as required by the Telecommunications Law. Each Public
Regime concession is a specific grant of authority that allows the
concessionaire to offer a wide variety of telecommunications services but
specifically prohibits the concessionaire from offering certain
telecommunications services and imposes certain obligations on the
concessionaire concerning network expansion and modernization, quality and
continuity of service. The main restriction is that, until December 31, 2003,
the regional fixed-line companies will be prohibited from offering
interregional and international long-distance service, while Embratel will be
prohibited from offering local service unless certain obligations are met as
described below. Anatel is required, some time after the privatization process
is complete, to grant Embratel the right to offer full intra-regional long-
distance service, which is currently restricted to the regional fixed-line
companies. See "--Obligations of Telecommunications Companies--Public Regime--
Service Restrictions."
18
<PAGE>
Concessions for Embratel and the three regional fixed-line companies are
granted for a fixed number of years, subject to certain obligations, with the
possibility of full renewal or revocation. See "--Obligations of
Telecommunications Companies--Public Regime--Service Restrictions." The
initial concessions for Embratel and the regional fixed-line companies have
been granted until 2005. After 2005, the concessions may be renewed. The
renewal period is currently 20 years. The current concessions granted to the
four companies in the Public Regime have not required the payment of a fee.
While terms for the grant of concessions to new entrants have not yet been
determined by Anatel, Embratel and the regional fixed-line companies are
required to pay biannual renewal fees after 2005 equal to 2% of annual net
revenues from the provision of fixed-line public telecommunications services
in the prior year (excluding taxes and social contributions) during the 20-
year renewal period.
Fixed-line Services--Private Regime. Licenses will be granted to new
competitors wishing to offer fixed-line-based services, including local,
intra-regional long-distance, interregional long-distance and international
long-distance, in the Private Regime. Licensees are not subject to the same
obligations as Public Regime concessionaires, although individual licenses may
contain certain obligations. After the privatization process for Embratel and
the three regional fixed-line companies is complete, Anatel is required to
authorize three new entrants to provide local telephone service and intra-
regional long-distance telephone service, with each of the three new entrants
receiving two licenses to provide such services in a single fixed-line Region,
in addition to authorizing one new entrant to provide intra-regional,
interregional and international telephone long-distance by granting three
licenses to provide such services throughout Brazil. The bidding requirements
are expected to contain certain minimum technical and financial standards. The
effective result of the license auction will be that two companies compete in
each of the markets for local service (one regional fixed-line concessionaire
and one licensee), four companies compete in the markets for intra-regional
long-distance service (one incumbent regional fixed-line company, Embratel,
and two licensees), and two companies compete in the markets for interregional
long-distance and international long-distance (Embratel and one licensee). See
"--Competition."
Until December 31, 2001, the four existing Public Regime concessionaires and
the new Private Regime licensees will be the only companies authorized to
offer local, intra-regional long-distance, interregional long-distance and
international long-distance services. Beginning January 1, 2002, the
Telecommunications Regulations require Anatel to end this period of
exclusivity and authorize new licensees wishing to offer such services. See
"--Competition."
Non-fixed Services--Private Regime--Concessions. The Band A and Band B
cellular companies are in the Private Regime. Pursuant to the Minimum Law and
the Telecommunications Law, the cellular companies in Band A and Band B have
been granted concessions. Each cellular concession is a specific grant of
authority to operate cellular services, subject to certain obligations
contained in the List of Obligations. If a cellular company wishes to offer
any telecommunications service other than the cellular service authorized by
its concession, it may apply to Anatel for a license to offer such other
services. See "--Non-fixed Services--Private Regime--Licenses."
Each cellular concession has been granted for an initial period of 15 years,
subject to renewal for further periods of 15 years if the List of Obligations
contained in a concession has been met. The Band A cellular concessions did
not require the payment of a fee. Terms of payment for renewal of the Band A
and Band B cellular concessions have not yet been established.
Currently, there is a limit on the number of cellular companies. One company
may operate in Band A and one company in Band B for each cellular region.
Under the cellular concessions, Anatel may not authorize additional providers
of cellular service until December 31, 1999.
Non-fixed Services--Private Regime--Licenses. Except for cellular service,
for which no new licenses may be granted until December 31, 1999, licenses may
be granted to any company wishing to offer non-fixed telecommunications
services in the Private Regime. Licensees are not subject to the same
obligations as Public Regime concessionaires, although individual licenses may
contain certain obligations.
19
<PAGE>
OBLIGATIONS OF TELECOMMUNICATIONS COMPANIES
Providers of telecommunications services are subject to certain obligations
contained in the List of Obligations of their concessions and licenses. The
four providers of telecommunications services in the Public Regime are subject
to a set of special restrictions regarding the services they may offer,
contained in the Plano Geral de Outorgas ("General Plan of Concessions and
Licenses"), and special obligations regarding service quality, network
expansion and modernization contained primarily in the Plano Geral de Metas de
Qualidade ("General Plan on Quality") and the Plano Geral de Metas de
Universalizacao ("General Plan on Universal Service"). These restrictions and
obligations are also contained in the concessions of the four companies,
particularly in the List of Obligations.
Public Regime--Service Restrictions. Under the General Plan on Concessions
and Licenses, Embratel and the regional fixed-line companies are prohibited
from offering certain basic fixed-line telecommunications services until they
fulfill the List of Obligations as described below. Embratel is prohibited
from offering local or cellular services and the regional fixed-line companies
are prohibited from offering cellular, interregional long-distance and
international long-distance services. Anatel is required, some time after the
privatization is effected, to grant Embratel the right to enter the market for
full intra-regional long-distance service, including service within the
states, as a competitor to the regional fixed-line companies and to grant the
fixed-line companies the right to offer interstate intra-regional long-
distance service, which they were not authorized to offer in the past.
The General Plan of Concessions and Licenses provides certain incentives to
encourage Embratel and the three regional fixed-line companies to fulfil the
service quality, network expansion and modernization obligations contained in
the List of Obligations quickly. Under the General Plan of Concessions and
Licenses, the progress of Embratel and the regional fixed-line companies
towards attaining their List of Obligations will be measured annually by
Anatel. Two measuring dates, December 31, 2001 and December 31, 2003 are of
particular importance (the "2001 Targets" and the "2003 Targets"). See tables
in "--Network Expansion--General Plan on Universal Service" and "--Quality of
Service--General Plan on Quality." In the period before the 2001 Targets are
measured, Anatel will regularly monitor the progress of Embratel and the
regional fixed-line companies and communicate with them. If they fail to meet
the 2001 Targets, Anatel may, at its discretion, revoke their concessions. If
they meet the 2001 Targets, they may continue to operate. In the period before
the 2003 Targets are measured, Anatel will regularly monitor the progress of
the four companies and communicate with them. If Embratel and the regional
fixed-line companies meet the 2003 Targets, the restrictions on the services
the four companies may offer will be eliminated and the companies will be
allowed to apply for licenses to offer any other service. In addition, if, in
its review for the 2001 Targets, Anatel finds that any of the four companies
has met the 2003 Targets, Anatel will immediately eliminate the restrictions
on the telecommunications services that company may offer. Anatel may also
eliminate the restrictions on a date other than the official measuring dates
of December 31, 2001 and December 31, 2003 if it finds that a company has met
the 2003 Targets. Failure to meet the 2003 Targets could result in revocation
of the Concessions.
In order to attract new entrants and ensure competition, there are also
certain restrictions on alliances, joint ventures, mergers and acquisitions
involving Public Regime concessionaires, including:
. A concessionaire is prohibited from holding more than 20 percent of the
equity in any other concessionaire
. Concessionaires offering different services in the Public Regime in
either the same or different regions are prohibited from offering
services jointly
. Concessionaires offering the same service in the Public Regime in
different regions are prohibited from offering services jointly
. Mergers between fixed-line regional companies and cellular companies are
prohibited
. Companies offering telephony services are prohibited from offering cable
television
Anatel has not yet determined whether the restrictions under its control
will expire in the future or under what conditions they would expire.
20
<PAGE>
Network Expansion--General Plan on Universal Service. Under the General Plan
on Universal Service, the regional fixed-line companies are required to expand
switched, fixed-line service to cover the entire national territory of Brazil
in accordance with the List of Obligations. Embratel is also subject to the
universal service requirement of providing access to direct-dial interregional
and international long-distance service by installing public telephones in
remote regions and isolated communities. Since universal service requirements
are restricted to the provision of switched, fixed-line basic telephony
services, formal universal service requirements do not apply to cellular
companies, although the cellular companies are subject to certain similar
requirements under the cellular List of Obligations and certain cellular
regulations, including obligations to expand their networks and to provide
cellular services without pricing discrimination within customer categories.
Universal service will be financed through two primary mechanisms: (a) the
normal capital expenditure budgets of Embratel and the regional fixed-line
companies, and (b) a universal service fund.
Embratel and the regional fixed-line companies are themselves responsible
for financing their universal service obligations of network expansion from
their own revenues. No subsidies or other supplemental financing is
anticipated to finance the network expansion obligations contained in the List
of Obligations. However, the General Plan on Universal Service allows Anatel
to waive the network expansion requirements once a company succeeds in meeting
the 2001 Target for maximum waiting time for installation of a line of four
weeks. If a regional fixed-line company fails to meet its obligations in a
particular region, Anatel may grant licenses to competing companies to provide
the service and may compel the regional fixed-line company to make its network
available for the competitor's use.
The following table sets forth the network expansion and modernization
obligations of the Company as stated in the List of Obligations for the period
1999-2005 and the Company's status with respect to each obligation as of
December 31, 1997.
NETWORK EXPANSION AND MODERNIZATION
<TABLE>
<CAPTION>
COMPANY STATUS BY DECEMBER 31,
AS OF DECEMBER 31, --------------------------------------
1997 1999 2000 2001 2002 2003 2004 2005
------------------ ----- ----- ----- ---- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Minimum total number of
installed lines in
millions............... 5.9 7.8 9.2 10.7 -- -- -- --
Fixed switched service
fully available if
population greater
than:.................. 300 inhabitants -- -- 1,000 -- 600 -- 300
Maximum waiting time for
installation of a line
(in weeks)(1).......... 76 -- -- 4 3 2 1 --
Minimum number of public
telephones in service
(in thousands)......... 168.6 217.5 242.9 271.3 -- -- -- --
Public telephones per
1,000 inhabitants...... 5.0 -- -- -- 7.5 -- 8.0
Minimum ratio of public
telephones to fixed
terminals (%).......... 0.03 -- -- -- -- 0.025 -- 0.03
Minimum digitalization
level
(% of network)......... 64.2 75 -- 85 -- 95 -- 100
Maximum distance to a
public telephone
(meters)(1)............ 500 800 -- 500 -- 300 -- --
Full-Service public
telephone
availability(2):
as a % of total number
of public telephones:
international long-
distance............. 61% 25 -- -- -- -- -- --
local and domestic
long-distance........ 100% 50 -- -- -- -- -- --
in areas with no fixed
switched service (# of
inhabitants).......... 200 1000 -- 600 -- 300 -- 100
</TABLE>
- --------
(1) Applies only to areas where fixed switched service is fully available.
(2) Public telephones available 24 hours a day with direct-dial capability.
21
<PAGE>
Quality of Service--General Plan on Quality. The General Plan on Quality
contains a series of service quality obligations that are incorporated into
the List of Obligations of Embratel and each regional fixed-line company.
These include attainment of certain targets such as reducing average dial tone
delay, achievement of certain call completion rates for local, intra-regional
long-distance, and interregional and international long-distance calls,
reducing average operator assistance delay, reducing trouble reports per 100
lines, reducing average time of repair, reducing average time of installation,
increasing billing accuracy, and achieving certain customer satisfaction
levels for public payphones, residential telephony and nonresidential
telephony.
The following table sets forth the quality of service obligations of the
Company as stated in the List of Obligations for the period 1999-2005 and the
Company's status with respect to each obligation as of December 31, 1997.
QUALITY OF SERVICE
<TABLE>
<CAPTION>
BY DECEMBER 31,
----------------------------------
COMPANY STATUS
AS OF
DECEMBER 31,
1997 1999 2000 2001 2002 2003 2004 2005
-------------- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Dial tone within 3 seconds
(% of cases)............... 99 98 -- 99 -- 99.5 -- --
Call completion rate during
peak periods (% of calls
attempted)(1).............. 56 60 -- 65 -- 70 -- --
Maximum busy circuit rate
during peak periods(1) (%
of calls attempted)........ 6 6 -- 5 -- 4 -- --
Maximum monthly repair
requests per line.......... .027 .03 -- .025 -- .02 -- .015
Maximum monthly public
telephone repair requests
per line................... 0.29 .15 -- .12 -- .10 -- .08
Residential repair response
speed (% within 24
hours)(2).................. 82 95 -- 96 -- 97 -- 98
Nonresidential repair
response speed (% within 8
hours)(3).................. 47 95 -- 96 -- 97 -- 98
Public telephone repair
response speed (% within 8
hours)..................... 44 95 -- 96 -- 97 -- 98
Operator availability during
peak periods (%
answer/within 10 seconds).. 61 92 -- 93 -- 94 -- 95
Billing inaccuracy
(inaccurate bills per 100
bills)(4).................. 0.6 .4 -- .3 -- .2 -- --
Credit issued within one
billing cycle for claimed
inaccuracies (% of cases).. 90 95 -- 96 -- 97 -- 98
</TABLE>
- --------
(1) For local and domestic long-distance calls.
(2) Must always be within 48 hours.
(3) Must always be within 24 hours.
(4) A bill is considered inaccurate for this purpose if a customer claims it
is inaccurate.
Failure to meet both network expansion and modernization obligations and the
quality of service obligations in the List of Obligations may result in fines
and penalties of up to R$50,000,000 as well as potential revocation of the
Company's Concession. The Company's ability to meet the quality of service
obligations in the List of Obligations will depend upon certain factors
outside its control. While there can be no assurances, the Company believes
that it will be able to meet these requirements.
Interconnection. Interconnection is mandatory between all telecommunications
networks upon request by any party. Interconnection tariffs are subject to a
price-cap established by Anatel. Rates below the applicable price-cap may be
negotiated between the parties. If a company offers an interconnection tariff
below the price-cap, it must offer that price to any other requesting party on
a non-discriminatory basis.
22
<PAGE>
Anatel has stated that it does not expect to grant parties requesting
interconnection the right to co-locate their equipment at this time. Co-
location means that a party requesting interconnection may place its switching
equipment in or near the local exchange of the network operator whose network
the requesting party wishes to use and connect to the network at this point of
presence. Co-location is currently a matter of negotiation between the
parties.
Anatel does not currently mandate unbundling of network elements and
services by the providers of such elements and services, although Anatel has
stated that it plans to review the issue on a regular basis and may introduce
unbundling in the future. In an unbundled regime, every network operator is
required to provide a detailed list of network services and elements which may
be purchased by a party requesting interconnection and the requesting party
then has the right to select and purchase a subset of the network elements and
services available.
Number Portability. Number portability is the ability of a customer to move
to a new home or office or switch service providers while retaining the same
telephone number. Full number portability is mandatory within a local area.
RATE REGULATION
General. In May 1997, a tariff rebalancing was implemented pursuant to which
monthly subscription charges and measured service charges for all customers
increased, while domestic and international long-distance rates were lowered.
In addition, the previous mechanism for financing the installation of new
lines (auto-financing), which required customers to purchase shares of
Telebras, was eliminated and replaced with a flat installation charge. With
retroactive effect as of April 1, 1998, the regime used to divide domestic and
international long-distance revenues between Embratel and the regional fixed-
line companies was replaced with a network usage fee for interconnection such
as already existed for use of cellular networks by the fixed-line companies
and for use of the fixed networks by cellular operators. In addition to the
network usage charge, Embratel is also required to pay a supplemental per-
minute charge called Parcela Adicional de Transicao ("PAT") that supplements
the network usage charge. Embratel is the only company that is required to pay
PAT charges. Embratel will be required to pay PAT charges for three years,
after which time the PAT charges will be phased out.
Price-Caps. Concessions with the regional fixed-line companies and Embratel,
including the Concessions with the Company, provide for a price-cap mechanism
to set and adjust rates on an annual basis. The price-cap mechanism consists
of a maximum amount, or price-cap, stipulated by Anatel, that may be charged
for a particular service and on a weighted average rate for a basket of basic
services. The services include all of the services in the basic service plan,
such as installation charges, monthly subscription fees, switched local
service, intra-regional long-distance, interregional long-distance and
international long-distance service, as well as public telephone service and
interconnection charges, including network usage fees. The main baskets for
the regional fixed-line companies are for local services, including
installation charges, the monthly subscription fee, and measured usage
charges, and for interconnection services, including network usage fees and
equipment rental charges. The main baskets for Embratel are interregional
long-distance, international long-distance and interconnection.
The initial price-cap established by Anatel in the Concessions is based on
the previously existing tariffs. The initial price-cap will be adjusted on an
annual basis under a formula contained in the Concessions. The formula allows
two adjustments to the price-cap. First, the price-cap is revised upward to
reflect increases in inflation by multiplying the price-cap by (1+1(y)), where
y represents the rate of inflation as measured by the Indice Geral de Precos--
Disponibilidade Interna ("IGP-DI"), an inflation index developed by the
Fundacao Getulio Vargas, a private Brazilian economic research organization.
Second, the inflation-adjusted price-cap is adjusted downward to ensure
productivity gains by multiplying the inflation-adjusted price-cap by (1-K),
where K represents a set productivity transfer factor (the "K-factor").
23
<PAGE>
In order to provide an incentive to Embratel and the regional fixed-line
companies to increase their efficiency and to reward consumers of
telecommunications services, Anatel applies a K-factor representing annual
productivity adjustments to the tariffs of Embratel and the regional fixed-
line companies. In the period 1998 to December 31, 2005, the tariffs of
Embratel and the regional fixed-line companies will be adjusted downward as
follows:
<TABLE>
<CAPTION>
K-FACTOR ANNUAL PRODUCTIVITY
ADJUSTMENTS
---------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-line companies--local............ 0% 0% 0% 1% 1% 1% 1% 1%
Fixed-line companies--local
interconnection....................... 0% 0% 0% 5% 10% 15% 20% 20%
Embratel--interregional long-distance.. 2% 2% 2% 4% 4% 4% 5% 5%
Embratel--international long-distance.. 5% 5% 15% 15% 15% 15% 15% 15%
Fixed-line companies--intra-regional
long-distance
and long-distance interconnection..... 2% 2% 2% 4% 4% 4% 5% 5%
</TABLE>
The price-cap covers a basket of basic services. While the weighted average
tariff for the entire basket may not exceed the price-cap, the tariffs for
individual services within the basket may be increased. The Company may
increase the tariff for any individual service by up to 9% for local services
and 5% for long-distance services, subject to a downward adjustment for
inflation effects already captured in the annual upward adjustments of the
overall price-cap for the basket, so long as it adjusts other prices downward
to ensure that the weighted average tariff does not exceed the price-cap.
The Company may also offer alternative plans in addition to the basic
service plan. For instance, a customer might wish to choose an alternative
plan that allows unlimited calling for a set fee rather than pay the per-
minute fee under the basic service plan. Alternative plans must be submitted
to Anatel for approval, but are not currently subject to a price-cap.
For information on the Company's current tariffs and service plans, see "--
Rates."
Installation Charges. Installation charges for connection to the fixed-line
telephone network have been reduced to a maximum flat rate of R$80 for all
customers, both residential and nonresidential as of October 1997. All
regional fixed-line companies are subject to this maximum for installation
uniformly in every local calling area throughout Brazil. Local areas include
those areas currently connected to the fixed-line network and correspond
largely to urban areas. Customers outside of the local areas must negotiate
the price of installation with the Company. Currently, the Company is charging
an installation charge of R$50, rather than R$80. This fee replaces the
autofinancing mechanism which had been in place, which required customers to
purchase shares in Telebras. See "--Rates--Local Services."
Monthly Subscription Charges. Residential and nonresidential customers must
pay a monthly access fee for connection to the fixed-line telephone network.
There are currently three levels of monthly access fees in Brazil, R$10, R$15
and R$20, excluding taxes, depending on customer characteristics, with all
residential customers paying R$10 and most business customers paying R$15. See
"--Rates--Local Services."
Measured Service Charges. Users of local service, both residential and
nonresidential, pay for local calls depending on usage. Usage is measured in
pulses. Pulses occur system-wide every four minutes for local calls. These
system-wide pulses are recorded independently of when individual calls are
actually made. In addition to system-wide pulses, the system records one
individualized pulse for every call when the call is connected. After the
first individualized pulse, only system-wide pulses are used in determining
the charge for a call. The result of this system is that, while the time
between the second and every subsequent pulse is always in increments of four
minutes, the time between the first (individualized) pulse and the second
(system-wide) pulse may vary. For example, the time between the first
(individualized) pulse and the second (system-wide) pulse may vary between one
second and four minutes.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from
24
<PAGE>
2:00 p.m. to midnight and all day Sunday and holidays, a caller is charged for
only one pulse regardless of the duration of a call.
All users of local service currently receive 90 free pulses per month as
part of their monthly subscription, equivalent to about 140 minutes per month
in the case of an average user. Through the tariff rebalancing of May 1997,
measured usage charges increased by approximately 61%. See "--Rates--Local
Services."
Anatel has stated that, as a consequence of its tariff restructuring in May
1997, cross-subsidies among various telecommunications services have been
largely eliminated.
Intra-Regional Long-Distance. Users of service pay differing rates for local
measured service and intra-regional long-distance service. Intra-regional
long-distance consists of interurban calls originating and terminating within
the calling area of a regional fixed-line company. The Company is allowed to
carry such calls entirely over its own network. When it does so, the Company
receives all of the revenues from such calls. As part of the May 1997 tariff
rebalancing, intra-regional long-distance rates were lowered, with an
effective reduction of approximately 32%. Intra-regional calls are billed
based on the duration of a call and distance. There are currently 20 intra-
regional long-distance tariffs based on combinations of four day/time
categories and five distance categories. Certain intra-regional long-distance
calls are made within an area code and are measured in pulses.
For a breakdown of the Company's current intra-regional long-distance
tariffs, see "--Rates--Intra-Regional Long-Distance Service."
Network Usage Charges. Other telecommunications companies wishing to
interconnect with and use the Company's network--primarily to gain access to
the Company's customers for call origination and completion--must pay certain
fees, primarily a network usage fee. In addition, other telecommunications
operators rent equipment, such as trunk lines, from the Company for use within
their own internal networks. Fees for network usage and equipment rental are
subject to price-caps stipulated by Anatel.
The price-cap for the network usage fee specified by Anatel varies from
company to company based on the underlying cost characteristics of each
company's network. The fee is a flat fee charged per minute of use which
represents an average charge for a basket of network elements and services.
Embratel, the cellular companies and any future new entrants into the market
must pay the network usage fee if they access end customers via the network of
a regional fixed-line company. In practical terms, even though the network
usage fee includes the costs of a variety of network elements and services,
the network usage fee primarily reflects the use of certain facilities of the
Company for which Embratel and the cellular companies do not have adequate
substitutes, particularly the local loop between local exchanges and end
customers. Anatel has stated that Embratel is likely to be the primary
provider of network usage fees since it will need to use at least the local
loop to access end customers for the provision of long-distance service and
since Embratel is under an obligation to provide universal long-distance
service.
In the past, the Company shared revenues for interstate and international
long-distance calls with Embratel rather than charging Embratel a network
usage fee for the use of the Company's network. Under this system, the Company
retained a fixed percentage of the revenues associated with such calls and
paid the balance of the revenues associated with such calls to Embratel. This
system was replaced with retroactive effect as of April 1, 1998 with the
interconnection charge regime that had already been in place for
interconnection of the Company's network with cellular networks, under which
the Company charges for connection to its network and usage of its network.
The total level of interconnection charges in the future is likely to depend
greatly on the interconnection regime adopted by Anatel and how it is
enforced. See "--Obligations of Telecommunications Companies--
Interconnection."
25
<PAGE>
BRAZILIAN POLITICAL ENVIRONMENT
The Brazilian political environment was marked by high levels of uncertainty
after the country returned to civilian rule in 1985, ending 20 years of
military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover at and immediately below the cabinet level,
adversely affected the implementation of consistent economic and monetary
policies, including consistent policies in the areas of government-owned
enterprises and telecommunications.
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real
Plan"), was elected President of Brazil in October 1994 and took office in
January 1995. He has generally sought to continue the economic stabilization
and liberalization policies he had developed as Finance Minister from May 1993
through April 1994. Although some important groups remain opposed to
significant elements of his program and the implementation of policies of
economic stabilization and liberalization is subject to significant
compromises and accommodations, President Cardoso is the leader of a coalition
of political parties that represents a majority of the federal Congress. His
party controls the state governments of the States of Sao Paulo, Rio de
Janeiro and Minas Gerais, and his policies have broad political support.
Elections for the President, Vice-President, state Governors and the members
of the Chamber of Deputies, as well as one third of the members of the Senate
were held on October 4, 1998. President Cardoso was re-elected for a second
term as president. The outcome of these elections could have a strong impact
on the continuation of the economic reforms of the Cardoso administration.
There can be no assurance that the political consensus in favor of the
economic reform program pursued by the Cardoso administration can or will be
sustained following the elections.
BRAZILIAN ECONOMIC ENVIRONMENT
The financial condition and results of operations of the Company are
dependent on general economic conditions in Brazil, and in particular on (i)
economic growth and its impact on demand for telecommunications services, (ii)
the cost and availability of financing and (iii) exchange rates between
Brazilian and foreign currencies.
For many years, the Brazilian economy was extremely volatile, and the
Federal Government implemented a succession of programs intended to stabilize
the economy and provide a basis for sustainable, non-inflationary growth. The
Company was affected by economic instability and by such programs in a variety
of ways, particularly when they have resulted in contractions in demand or
very high real interest rates or prevented the Company from raising rates to
keep pace with the rate of inflation.
Until the introduction of the Real Plan, measures by the Federal Government
intended to influence the course of Brazil's economy, such as changes in
monetary, credit, tariff and other policies, were frequent and occasionally
drastic. See "Exchange Controls and Other Limitations Affecting Security
Holders." In particular, actions to control inflation, interest rates or
consumption included freezing bank accounts, imposing capital controls,
introducing high tariffs and other strong measures. Changes in policy, social
instability and other political and economic developments, and the Brazilian
government's responses to such developments, not infrequently have had a
material adverse effect on the Company's business, financial condition and
results of operations.
Beginning in December 1993, the Federal Government introduced the Real Plan,
an economic stabilization program intended to reduce the rate of inflation by
reducing certain public expenditures, collecting liabilities owed to the
Federal Government, increasing tax revenues, continuing to privatize
government-owned entities and introducing a new currency. The real was
introduced as Brazil's currency on July 1, 1994, based on a new unit of
account, the URV, introduced earlier in the year. Since taking office in
January 1995, President Cardoso has
26
<PAGE>
continued to implement the Real Plan. The real generally appreciated through
January 1995 and thereafter gradually declined in value against the dollar,
reaching R$1.1164 to US$1.00 at December 31, 1997. Under the Real Plan, the
rate of inflation has decreased significantly and there has been sustained
growth in real gross domestic product. See "--Inflation and Devaluation."
Notwithstanding the success of the Real Plan in lowering inflation and
stabilizing the Brazilian economy, the Real Plan also led to an economic
slowdown, a rise in unemployment in some regions and specific sectors of the
economy, and adversely impacted certain sectors of the economy.
Beginning in August 1998, following the devaluation of the Russian Ruble,
Brazil has experienced substantial capital outflows, significant declines in
its stock markets and speculative attacks on the Brazilian currency. In
response, the Federal Government has raised interest rates and stated that it
will continue to support the value of the real and to abide by the principles
inherent in the Real Plan. In early October 1998, reported capital outflows of
approximately US$1 billion per day led to speculation that the International
Monetary Fund would provide Brazil with a financial aid package. However, as
of October 9, 1998, no such package had been announced by the IMF or formally
requested by the Federal Government. Previously, in the fourth quarter of
1997, Brazil experienced a financial crisis following the financial and
economic crisis in Asia. In response, the Federal Government adopted several
economic measures to protect the Real Plan and the stability of the Brazilian
currency. These measures included (i) an increase in interest rates, including
a near doubling of short-term interest rates, (ii) an increase in certain tax
rates, (iii) a reduction in Federal Government spending for 1998 and (iv)
restrictions on imports. Government policies to control inflation and to
reduce budget and trade deficits could also result in further actions that
could slow or halt Brazilian economic growth. It is not possible to foresee
how measures like these will affect the business, financial condition and
results of operations of the Company.
Brazil's trade deficit for 1997 increased to US$8.37 billion compared to
US$5.54 billion for 1996. There can be no assurance that the Brazilian
government will not introduce credit restrictions to subdue domestic demand in
order to reduce the trade deficit, nor that any such credit restrictions will
not have a material adverse effect on the business, operations, financial
condition or results of operations of the Company. A continuing increase in
the trade deficit would substantially reduce Brazil's approximately US$50.8
billion of reserves at December 31, 1997 and could negatively affect Brazil's
economic development as a whole.
PRIVATIZATION
The Federal Government, directly or through various state-owned enterprises,
owns many companies and controls a major portion of activities in the oil and
gas sectors. Most of the energy production and postal services companies are
directly or indirectly controlled by the Federal Government.
To reduce its participation in the economy, the Federal Government has
engaged in the privatization of certain state enterprises. The objectives of
the privatization program are (i) to reduce the role of the state in the
economy and allocate more resources to social investment, (ii) to reduce
public sector debt, (iii) to encourage increased competition and thereby raise
the standards and efficiency of Brazilian industry and (iv) to strengthen the
capital markets and promote wider share ownership. As originally presented the
Real Plan contemplated constitutional amendments which would permit private
participation in the state-controlled petroleum and telecommunications sectors
and in other areas that had constitutionally mandated monopolies, such as
pipeline distribution of gas and the shipping industry. These amendments were
approved by Congress in 1995. A council directly subordinate to the President,
the Conselho Nacional de Privatizacao (the "Privatization Council"), and Banco
Nacional de Desenvolvimento Economico e Social (the "National Development
Bank" or "BNDES") are responsible for administering the privatization program.
As of December 31, 1996, a total of 52 state enterprises or divisions
thereof had been privatized, and several minority interests held by Federal
Government companies had been sold for nominal consideration totaling US$13.7
billion (including payment made in Brazilian currency and payment made by
means of qualified debt instruments issued to the federal government, its
agencies and state-controlled companies). To date, the privatizations have,
for the most part, been effected through share auctions conducted on Brazil's
stock
27
<PAGE>
exchanges. Although the majority of such share auctions have been successful,
there have been instances in which a share auction has failed due to lack of
bidders. Although the majority of such share auctions have been successful,
there have been instances in which a share auction has failed due to a lack of
bidders. Privatization revenues for 1997 exceeded $26.0 billion. Some of the
Brazilian states, such as Sao Paulo, Minas Gerais, Pernambuco, Paraiba and
Maranhao are also conducting privatization programs in relation to state
services.
Brazilian labor unions have opposed certain of the privatization measures
proposed by the Brazilian Government, but the Federal Government has, to date,
been able to move forward with its program despite such opposition.
DEVELOPMENTS IN OTHER EMERGING MARKET COUNTRIES; BRAZILIAN AUSTERITY PROGRAM
The Brazilian securities markets are, to varying degrees, influenced by
economic and market conditions in other emerging market countries. Although
economic conditions are different in each country, investors' reactions to
developments in one country can have an effect on the securities of issuers in
other countries, including Brazil. For example, since the fourth quarter of
1997, the international financial markets have experienced significant
volatility, and a large number of financial market indices, including those in
Brazil, have declined significantly. The current market volatility in Latin
America and other emerging market countries' securities markets has also been
attributed, at least in part, to the effects of the Asian economic crisis.
There can be no assurance that the Brazilian securities markets will not
continue to be affected negatively by events elsewhere, especially in emerging
markets, or that such events will not adversely affect the value of the ADSs.
In reaction to the growing market volatility in Asia, the Federal Government
implemented several measures intended to curtail the outflow of foreign
investment, as Central Bank reserves were reduced from U.S.$61.2 billion in
September 1997 to U.S.$52.9 billion by the end of October 1997. On October 30,
1997, the Central Bank raised the benchmark interest rate from 20.7% to 43.4%
in order to retain investment funds in the country. On November 10, 1997 the
Federal Government presented a series of fiscal measures aimed at reducing the
budget deficit and bolstering economic conditions. The measures included
certain tax increases, eliminations of budget expenses and reductions in
available fiscal incentives. The package of measures was intended to produce a
savings of R$20 billion, due to the decrease in expenses and the increase in
revenue. These fiscal measures have been substantially implemented.
Constitutional reforms affecting civil servants and social security have also
been accelerated and may result in lower government deficits. However, there
can be no assurance that such measures will be successful in protecting the
Federal Government's present currency exchange rate policy and price stability
program.
Additionally, the decrease in economic activity caused by the increase in
interest rates and the fiscal measures may have substantial negative effects on
companies doing business in Brazil. Projected GDP growth for Brazil for 1998
has been reduced from approximately 4% to approximately 1%. It is expected that
these events may have the effect of reducing the purchasing power of Brazilian
consumers in general. Since the increase in interest rates, the Central Bank
has gradually reduced its benchmark interest rate, setting its rates at 40.9%
on December 1, 1997, at 38.0% on January 2, 1998, at 34.5% on January 29, 1998,
at 28.0% on March 5, 1998, at 21.8% on May 20, 1998, at 21.0% on June 25, 1998
and at 19.75% on July 29, 1998. There can be no assurance that a decrease in
interest rates will not cause further investment outflows.
Events in Asia also may affect the competitiveness of Brazilian exports. In
addition, the proceeds from scheduled privatizations may not reach expected
levels, in which case the current account deficit would cause a deterioration
in foreign reserves, adversely affecting the currency exchange rate policy.
28
<PAGE>
INFLATION AND DEVALUATION
Brazil experienced extremely high and generally unpredictable rates of
inflation and of devaluation of Brazilian currency for many years until the
implementation of the Real Plan. Inflation itself, as well as certain
governmental measures to combat inflation, and public speculation about
possible future actions have also historically contributed to economic
uncertainty in Brazil and to heightened volatility in the Brazilian securities
markets. The following table sets forth Brazilian inflation, as measured by
the UFIR for 1995 and the IGP-M for 1996-1998, and the devaluation of the
Brazilian currency against the U.S. dollar for the periods shown.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, FIRST QUARTER SIX MONTHS
-------------- ENDED MARCH 31, ENDED JUNE 30,
1995 1996 1997 1998 1998
---- ---- ---- --------------- --------------
(IN PERCENTAGES)
<S> <C> <C> <C> <C> <C>
Inflation (UFIR for 1995; IGP-M
for 1996-1998)................. 22.5 9.2 7.7 1.3 2.0
Devaluation (Brazilian currency
vs. US$)....................... 15.0 6.9 7.4 1.9 3.6
</TABLE>
Since the introduction of the Real Plan in July 1994, the rate of inflation
has decreased considerably. As measured by the IGP-M, the rate of inflation
was 7.7% for 1997, 1.3% for the first quarter of 1998 and 2.0% for the six
months ended June 30, 1998. Despite this reduction, the rate of inflation
remains high compared to other countries, and the potential for distortions or
dislocations attributable to changing prices continues to exist. The exchange
rate between the real and the U.S. dollar has also been relatively stable
since early July 1994, compared to prior periods, although the potential for
devaluation or volatility persists. See "Exchange Rates."
ITEM 2: DESCRIPTION OF PROPERTY
The principal properties of the Company consist of transmission plants
(including outside plant and trunk lines), exchange equipment and switching
equipment. The Company's land and buildings principally consist of its
telephone exchanges and other technical, administrative and commercial
properties. Exchanges include local exchanges, "toll" exchanges that connect
local exchanges to long-distance transmission facilities and "tandem"
exchanges that connect local exchanges with each other and with toll
exchanges.
The Company's properties are located throughout the state of Sao Paulo. At
March 31, 1998, the Company utilized 1,673 properties, of which 1,392 sites
were owned by the Company. Telesp owns the building in Sao Paulo from which
the majority of its management activities are conducted. Pursuant to Brazilian
legal procedures, liens have been placed on several of the Company's
properties pending the outcome of various legal proceedings to which the
Company is a party.
At December 31, 1997, plant and equipment related to switching stations
represented approximately 25.0%, transmission equipment represented 32.5%,
construction in progress represented approximately 11.0%, buildings,
underground equipment and lines represented approximately 23.4% and other
fixed assets represented approximately 8.1% of the net book value of the
Company's total fixed assets. At December 31, 1997, the net book value of the
Company's property, plant and equipment was R$12,589.4 million.
ITEM 3: LEGAL PROCEEDINGS
The Breakup of Telebras is subject to several lawsuits in which the
plaintiffs have requested, and in certain cases obtained, preliminary
injunctions against the Breakup. All of these preliminary injunctions have
been quashed by decisions of the relevant Federal Court, although several of
such decisions are currently on appeal. If any such appeal is successful, the
shareholders of Telebras will be required to reapprove the Breakup or other
legislative action may be required.
The lawsuits to which the Breakup has been subjected are based on a number
of legal theories, the principal among which are that (i) Brazil's
Constitution requires that the creation of the twelve New Holding Companies be
specifically authorized by the Telecommunications Law--the Breakup is not so
authorized; (ii) the
29
<PAGE>
shareholders' meeting of Telebras held on May 22, 1998 which approved the
Breakup was not properly convened; (iii) national sovereignty will be
threatened if the country's telecommunications companies are controlled by
foreign entities; and (iv) the Telecommunications Law requires that certain
matters, such as the entry of new competitors and the administration of
development and technology funds, be regulated prior to the Breakup and
privatization either by an executive order of the President or by an act of
Congress. If any of the plaintiffs in the above-described lawsuits ultimately
prevails, the Breakup will have to be reinitiated. This could require,
depending upon the prevailing plaintiff's theory, any combination of (i)
amendment of the Telecommunications Law, (ii) reconvening the May 22, 1998
Telebras shareholders' meeting and (iii) the passage of additional laws by
Congress or issuance of executive orders by the President. It is theoretically
possible under Brazilian law for a court to require that the Breakup be
unwound, although the Company believes that this would not be likely to occur.
The Company is a party to certain legal proceedings arising in the normal
course of business, including civil, administrative, tax, social security and
labor proceedings. The Company has provided for or deposited in court amounts
to cover its estimated losses due to adverse legal judgments. In the opinion
of management, such actions, if decided adversely to the Company, would not
have a material adverse effect on the Company's business and financial
condition.
The Company is a party to several lawsuits filed by the National Institute
of Social Security in 1997 before the Federal Courts of Sao Paulo relating to
the collection of the Contribuicoes devidas ao Seguro de Acidente de Trabalho
(Workers Accident Insurance Tax or "SAT") for the period between January 1986
and June 1996. The aggregate amount involved in such lawsuits is approximately
R$100 million. The Company has allowed judicial liens to be placed on five of
its properties, valued at approximately R$61.6 million in the aggregate,
pursuant to Brazilian legal procedures pending the outcome of such lawsuits.
In the event the Company prevails in such lawsuits, such liens will be lifted
from the properties.
A class action suit was filed against the Company in 1995 seeking an
injunction against the Company's "servicos 900" (code 900 services). While the
Company believes that it will prevail on the merits in this civil action, the
Company faces an estimated loss in revenues of approximately R$72 million per
year if an injunction is granted.
Telebras is the legal predecessor of the Registrant and is a defendant in a
number of legal proceedings and subject to certain other claims and
contingencies.
Under the terms of the Breakup, liability for any claims arising out of acts
committed by Telebras prior to the effective date of the Breakup remains with
Telebras, except for labor and tax claims (for which Telebras and the New
Holding Companies are jointly and severally liable by operation of law) and
any liability for which specific accounting provisions have been assigned to
the Registrant or one of the other New Holding Companies. Creditors of
Telebras may challenge this allocation of liability until September 14, 1998.
Management of the Company believes that the chances of any such claims
materializing and having a material adverse financial effect on the Company
are remote.
Liability for any claims arising out of acts committed by Telesp prior to
the effective date of the spin-off of Telesp's cellular assets and liabilities
to Telesp Celular S.A. ("Telesp Cellular") remains with Telesp Cellular,
except for labor and tax claims (for which Telesp and Telesp Cellular are
jointly and severally liable by operation of law) and those liabilities for
which specific accounting provisions have been assigned to Telesp Cellular.
However, under the shareholders' resolution pursuant to which the spin-off was
effected, Telesp Cellular has contribution rights against Telesp with respect
to the entire amount of any payments made by Telesp Cellular in connection
with any labor or tax claims brought against Telesp Cellular and relating to
acts committed by Telesp prior to the effective date of the spin-off.
ITEM 4: CONTROL OF REGISTRANT
Of the Company's two classes of capital stock outstanding, only the Common
Shares have full voting rights. The Preferred Shares have voting rights under
limited circumstances. See "Description of the Securities to be
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<PAGE>
Registered--Capital Stock--Voting Rights." Tele Brasil Sul owns 51.8% of the
Common Shares. Accordingly, Tele Brasil Sul has the ability to control the
election of the Company's Board of Directors and the direction and future
operations of the Company.
The following table sets forth information concerning the ownership of
Common Stock by Tele Brasil Sul and by the Company's officers and directors as
a group. The Company is not aware of any other shareholder owning more than
10.0% of the Common Shares.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
COMMON OUTSTANDING
NAME OF OWNER SHARES OWNED COMMON SHARES
------------- -------------- -------------
<S> <C> <C>
Tele Brasil Sul.................................. 64,405,151,125 51.79%
All directors and executive officers as a group
(5 persons)..................................... 37,847 0.00%
</TABLE>
The following is a brief description of the shareholders of Tele Brasil Sul.
TELEFONICA INTERNACIONAL S.A. Telefonica Internacional S.A. is a subsidiary
of Telefonica de Espana S.A. ("Telefonica"). Telefonica is dedicated to the
telecommunications sector, with activities in Spain and Portugal and in the
Americas. Telefonica provides a comprehensive range of telecommunications
services, including fixed, mobile and public telephone services to the
residential and business markets, as well as international calls, data
transmission and infrastructure services. Its shares are listed on the Madrid
Stock Exchange and on the New York Stock Exchange. Telefonica is also a
participant in the consortia that acquired control of three other New Holding
Companies: Tele Leste Celular Participacoes S.A., Telesp Celular Participacoes
S.A. and Tele Sudeste Celular Participacoes S.A.
PORTUGAL TELECOM S.A. Portugal Telecom is part of the Portugal Telecom Group
("Portugal Telecom"). Portugal Telecom is a company dedicated to the
telecommunications sector, more specifically to the establishment, management
and exploration of the telecommunications' infrastructures and the supply of
telecommunications services. It also provides the services of distribution of
telecommunications diffusion signals. Portugal Telecom is also a participant
in the consortia that acquired control of another New Holding Company: Telesp
Celular Participacoes S.A.
BANCO BILBAO VIZCAYA. Banco Bilbao Vizcaya ("BBV") is part of a Spanish
financial group with presence in 35 countries. BBV's principal business is
retail banking, in which BBV accounts more than 6.5 million clients. It also
provides other services related to retail banking, such as telephone and
computer banking. In addition to retail banking, BBV has six other core
business areas, each of which focuses on a certain group of clients or
markets, or has its own geographic responsibilities. These areas include banks
in Spain, banks abroad, wholesale banking, private banking and asset
management and diversification.
IBERDROLA S.A. Iberdrola is an electric power company whose major activity
is the generation, transportation, distribution and marketing of electricity.
Iberdrola is also engaged in sectors such as new energy, engineering,
consultancy, telecommunications, information systems, real estate, and added
value services to customers. In Spain, it provides electricity to its more
than eight million customers, which represent 40% of the peninsular domestic
market. Iberdrola performs activities in 23 companies set up in Argentina,
Bolivia, Brazil, Colombia, Chile and Guatemala, and participates in the
management of electricity, gas and telecommunications supply to over ten
million customers in those countries. Iberdrola is also a participant in the
consortia that acquired control of two other New Holding Companies: Tele Leste
Celular Participacoes S.A. and Tele Sudeste Celular Participacoes S.A.
RBS PARTICIPACOES S.A. RBS Participacoes S.A. is a family-owned holding
company dedicated to investing in the telecommunication, television and media
businesses.
ITEM 5: NATURE OF TRADING MARKET
There has never been a trading market for the ADSs. Prior to September 21,
1998, there was no trading market for the Common Shares or the Preferred
Shares. The common shares and preferred shares of Telesp have
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<PAGE>
traded on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges") since May 18, 1998. Prior to that date, Telesp shares traded on
such exchanges as units with shares of Telesp Cellular. Prior to the spin-off
of Telesp's cellular operations to Telesp, common shares and preferred shares
of Telesp traded on the Brazilian Stock Exchanges.
The table below sets forth, for the periods indicated, the high and low
closing sales prices for the preferred shares of Telesp as reported on the Sao
Paulo Stock Exchange since the spin-off of Telesp's cellular operations. The
market price of the Preferred Shares may differ materially from the market
price of the preferred shares of Telesp. Two factors accounting for this
difference are expected to be (i) that the Registrant has certain assets and
liabilities that Telesp does not (see Note 23 to the Consolidated Financial
Statements) and (ii) that the capital structure of Telesp differs
significantly from that of the Registrant. As of May 18, 1998, Telesp had
29,662,618,749 common shares and 27,659,105,063 preferred shares outstanding.
Telesp's capital structure is different from that of the Registrant. See
"Description of Securities to be Registered--Capital Stock--General."
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
TELESP (1)
-------------------
HIGH LOW
-------------------
(IN NORMAL REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998....................... R$ 300.00 R$ 220.00
June 1, 1998 through June 30, 1998...................... R$ 282.00 R$ 232.00
July 1, 1998 through July 31, 1998...................... R$310.00 R$ 257.00
August 1, 1998 through August 31, 1998.................. R$280.00 R$ 167.00
September 1, 1998 through September 30, 1998............ R$191.00 R$110.00
</TABLE>
- --------
(1) Share prices are for Telesp, a subsidiary of the Registrant, and not for
the Registrant itself.
Following the Breakup and until September 21, 1998, the preferred shares of
each of the New Holding Companies, including the Preferred Shares, traded on
the Brazilian Stock Exchanges only as a unit with the preferred shares of
Telebras. Telebras ADSs, each representing 1,000 Telebras preferred shares
and, since the Breakup, each also representing 1,000 preferred shares of each
of the New Holding Companies, have continued to trade on the NYSE.
On September 21, 1998, common shares and preferred shares of each New
Holding Company, including the Preferred Shares, commenced trading separately
on the Brazilian Stock Exchanges. The table below sets forth, for the periods
indicated, the high and low closing sales prices for the Preferred Shares of
the Registrant as reported on the Sao Paulo Stock Exchange.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
THE REGISTRANT
-------------------
HIGH LOW
-------------------
(IN NOMINAL REAIS)
<S> <C> <C>
September 21, 1998 through September 30, 1998........... R$ 30.50 R$ 27.50
October 1, 1998 through October 23, 1998................ R$ 34.00 R$ 24.00
</TABLE>
It is expected that during the fourth quarter of 1998 American Depositary
Shares representing preferred shares of each New Holding Company will be
issued and commence trading separately on the NYSE. The ADSs, each
representing 1,000 Preferred Shares of the Registrant, will be issued to the
holders of Telebras ADSs pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, The Bank of New York as Depositary (the
"Depositary") and the holders of the ADSs from time to time. See "Description
of Securities to be Registered--Description of American Depositary Receipts in
respect of Preferred Shares."
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<PAGE>
Application has been made to list the ADSs on the NYSE upon issuance under
the symbol TSP. Prices at which the Preferred Shares and the ADSs may trade
cannot be predicted. There can be no assurance that an active trading market
for the Preferred Shares in Brazil or for the ADSs in the United States or
elsewhere will develop or be sustained.
TRADING ON THE BRAZILIAN STOCK EXCHANGES
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1997, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a non-profit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized non-members. The Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange have two open outcry trading sessions
each day, from 10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 5:00 p.m. Trading
is also conducted during this time on an automated system on the Sao Paulo
Stock Exchange and on the National Electronic Trading System ("SENN"), a
computerized system that links the Rio de Janeiro Stock Exchange
electronically with the seven smaller regional exchanges. Market makers exist
on the Sao Paulo Stock Exchange, but are only authorized to make markets in
options for stock indices which are traded on that exchange and to engage in
transactions on META (Mercado de Empresas Teleassistidas), an electronic
trading system operating at the Sao Paulo Stock Exchange and permitting
trading in the securities of companies registered for that purpose. These
companies must appoint the market makers authorized to deal in their
securities. There are no specialists or market makers for the Company's shares
on the Sao Paulo Stock Exchange. The Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM") and each of the Brazilian stock
exchanges have discretionary authority to suspend trading in shares of a
particular issuer under certain circumstances. Trading in securities listed on
the Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of separate clearinghouses for each
exchange, which maintain accounts for member brokerage firms. The seller is
ordinarily required to deliver the shares to the exchange on the second
business day following the trade date. The clearinghouse for the Sao Paulo
Stock Exchange is Calispa S.A., which is owned by the member brokerage firms.
The clearinghouse for the Rio de Janeiro Stock Exchange is CLC-Camara de
Liquidacao e Custodia S.A., which is 99% owned by that exchange.
At December 31, 1997, the aggregate market capitalization of the 536
companies listed on the Sao Paulo Stock Exchange was approximately R$285.0
billion. Substantially the same securities are listed on the Sao Paulo Stock
Exchange and on the Rio de Janeiro Stock Exchange. Although all the
outstanding shares of an exchange-listed company may trade on a Brazilian
stock exchange, in most cases less than half of the listed shares are actually
available for trading by the public, the remainder being held by small groups
of controlling persons that rarely trade their shares. This is particularly
true in the case of mixed-capital companies, such as the Company before the
privatization, of which more than half of the voting shares must by law be
owned by Brazilian governmental entities. For this reason, data showing the
total market capitalization of Brazilian stock exchanges tends to overstate
the liquidity of the Brazilian equity securities market.
Although the Brazilian equity market was Latin America's largest in terms of
market capitalization, it is relatively small and illiquid compared to major
world markets. In 1997, the combined daily trading volumes on these two
exchanges averaged approximately R$945.4 million. In 1997, the five most
actively traded issues represented approximately 72.9% of the total trading in
the cash market on the Sao Paulo Stock Exchange and approximately 50.5% of the
total trading in the cash market on the Rio de Janeiro Stock Exchange.
33
<PAGE>
Trading on Brazilian stock exchanges by non-residents of Brazil is subject
to certain limitations under Brazilian foreign investment legislation. See
"Description of Securities to be Registered."
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the CVM, which has
authority over stock exchanges and the securities markets generally, and by
the Central Bank of Brazil, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. The Brazilian securities market is governed by Law No. 6,385
dated December 7, 1976, as amended (the "Brazilian Securities Law"), and the
Brazilian Corporation Law.
Under the Brazilian Corporation Law, a company is either public, a
"companhia aberta," such as the Company, or private, a "companhia fechada."
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
("Brazilian OTC") market. The shares of a public company, including the
Company, may also be traded privately, subject to certain limitations. To be
listed on the Brazilian stock exchanges, a company must apply for registration
with the CVM and the stock exchange where the head office of the company is
located. Once this stock exchange has admitted a company to listing and the
CVM has accepted its registration as a public company, its securities may be
traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading
may also be suspended on the initiative of a Brazilian stock exchange or the
CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provided for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
Until the Registrant was privatized, it was subject to provisions of
Brazilian corporate law applicable to mixed-capital companies under Brazilian
law. These provisions ceased to apply after the Registrant was privatized. As
a mixed-capital company, the Registrant was not subject to bankruptcy and the
Federal Government was contingently liable for the obligations of the
Registrant for so long as its assets were encumbered and attached. However,
substantial limitations applied to the attachment or sale of assets of the
operating subsidiaries of the Registrant that were used to provide
telecommunications services pursuant to the Company's concession. Similarly,
the sale of shares representing voting control of operating subsidiaries
providing public telecommunications services was subject to government
authorization. The sale of preferred shares of operating subsidiaries, or of
assets not used to provide telecommunications services, was not subject to
these restrictions.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with
the Central Bank of Brazil. Such restrictions on the remittance of foreign
capital abroad may hinder or prevent Banco Itau S.A. (the "Custodian"), as
custodian for the Preferred Shares represented by ADSs, or holders who have
exchanged ADRs for Preferred Shares from converting dividends, distributions
or the proceeds from any sale of such Preferred
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Shares, as the case may be, into U.S. dollars and remitting such U.S. dollars
abroad. Holders of ADSs could be adversely affected by delays in, or refusal
to grant any, required government approval for conversions of Brazilian
currency payments and remittances abroad of the Preferred Shares underlying
the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies,
pension and investment funds, charitable foreign institutions and other
institutions that (i) seek to invest in financial markets and (ii) meet
certain minimum capital and other requirements) registered with the CVM and
acting through authorized custody accounts managed by local agents may buy and
sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex
IV Regulations are also entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations." Resolution No. 1,927 of the National Monetary
Council, which is the restated and amended Annex V to Resolution No. 1,289 of
the National Monetary Council (the "Annex V Regulations"), provides for the
issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program will be approved under the Annex V
Regulations by the Central Bank of Brazil and the CVM prior to the issuance of
the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders
outside Brazil are free of Brazilian foreign investment controls and holders
of the ADSs will be entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations."
A Certificate of Registration will be issued in the name of the Depositary
with respect to the ADSs prior to the issuance of the ADSs and will be
maintained by the Custodian on behalf of the Depositary. Pursuant to the
Certificate of Registration, the Custodian and the Depositary are able to
convert dividends and other distributions with respect to the Preferred Shares
represented by ADSs into foreign currency and remit the proceeds outside
Brazil. In the event that a holder of ADSs exchanges such ADSs for Preferred
Shares, such holder will be entitled to continue to rely on the Depositary's
Certificate of Registration for five business days after such exchange,
following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank of Brazil. Thereafter, any holder of
Preferred Shares may not be able to convert into foreign currency and remit
outside Brazil the proceeds from the disposition of, or distributions with
respect to, such Preferred Shares, unless such holder (i) qualifies under the
Annex IV Regulations or (ii) obtains its own Certificate of Registration, and
in the case of (ii), it will be subject to less favorable Brazilian tax
treatment than a holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event
of a serious imbalance or an anticipated serious imbalance of Brazil's balance
of payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central
Bank of Brazil that were owed to foreign equity investors, in order to
conserve Brazil's foreign currency reserves. These amounts were subsequently
released in accordance with Federal Government directives. The imbalance in
Brazil's balance of payments increased during 1997, and there can be no
assurance that the Federal Government will not impose similar restrictions on
foreign repatriations in the future.
ITEM 7: TAXATION
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the acquisition, ownership and
disposition of Preferred Shares or ADSs, but it does not purport to be a
comprehensive description of all the tax considerations that may be relevant
to a decision to purchase Preferred Shares or ADSs. The summary is based upon
the tax laws of Brazil and regulations thereunder and on the tax laws of the
United States and regulations thereunder as in effect on the date hereof,
which are subject to change. This summary is also based upon the
representations of the Depositary and on the assumption that each obligation
in the Deposit Agreement relating to the ADRs and any related documents will
be performed in accordance with its terms. PROSPECTIVE PURCHASERS OF PREFERRED
SHARES OR ADSs SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX
CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF PREFERRED SHARES
OR ADSs.
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Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares
or ADSs should consult their own tax advisors as to the tax consequences of
the acquisition, ownership and disposition of Preferred Shares or ADSs in
their particular circumstances.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the principal Brazilian tax consequences
of the acquisition, ownership and disposition of Preferred Shares or ADSs by a
holder that is not domiciled in Brazil for purposes of Brazilian taxation and,
in the case of a holder of Preferred Shares, that has registered its
investment in Preferred Shares with the Central Bank of Brazil as a U.S.
dollar investment (in each case, a "non-Brazilian holder"). It is based on
Brazilian law as currently in effect. Any change in such law may change the
consequences described below. The following discussion summarizes the
principal tax consequences applicable under current Brazilian law to non-
Brazilian holders of Preferred Shares or ADSs; it does not specifically
address all of the Brazilian tax considerations applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor concerning the Brazilian tax consequences of an investment in
Preferred Shares or ADSs.
TAXATION OF DIVIDENDS
Dividends, including dividends paid in kind, paid by the Company (i) to the
Depositary in respect of the Preferred Shares underlying the ADSs or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be
subject to Brazilian withholding tax in the case of distributions of profits
earned as from January 1, 1996. Stock dividends relating to profits generated
prior to December 31, 1995 are not subject to withholding tax in Brazil unless
the stock is redeemed by the Company within five years from such distribution
or the non-Brazilian holder sells the stock in Brazil within such five-year
period.
Brazil has entered into tax treaties with several countries. However, there
is currently no tax treaty between the United States and Brazil. The only
Brazilian tax treaty now in effect that, if certain conditions are met, would
reduce the rate of the withholding tax on dividends in respect of profits
generated prior to December 31, 1995 below the generally applicable 15% rate
is the treaty with Japan, which would reduce such rate to 12.5% under the
circumstances stated in such treaty.
TAXATION OF GAINS
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
The withdrawal of Preferred Shares in exchange for ADSs is not subject to
Brazilian tax. The deposit of Preferred Shares in exchange for ADSs is not
subject to Brazilian tax provided that the Preferred Shares are registered
under the Annex IV Regulations. In the event the Preferred Shares are not so
registered, the deposit of Preferred Shares in exchange for ADSs may be
subject to Brazilian capital gains tax at the rate of 10% or 15% as described
below. On receipt of the underlying Preferred Shares, a non-Brazilian holder
who qualifies under the Annex IV Regulations will be entitled to register the
U.S. dollar value of such shares with the Central Bank of Brazil as described
below under "--Registered Capital."
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
sales of Preferred Shares that occur abroad or on the proceeds of a redemption
of, or a liquidating distribution with respect to, Preferred Shares. As a
general rule, non-Brazilian holders are subject to a withholding tax imposed
at a rate of 15% on gains realized on sales or exchanges of Preferred Shares
that occur in Brazil to or with a resident of Brazil outside of a Brazilian
stock exchange. Non-Brazilian holders are generally subject to a withholding
tax at a rate of 10% on gains realized
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on sales or exchanges in Brazil of Preferred Shares that occur on a Brazilian
stock exchange but will not be subject to tax if either such a sale is made
within five business days of the withdrawal of such Preferred Shares in
exchange for ADSs and the proceeds thereof are remitted abroad within such
five-day period, or such a sale is made under the Annex IV Regulations by
certain qualified institutional non-Brazilian holders that register with the
CVM. Gains realized by an investor under the Annex IV Regulations are not
subject to tax, provided certain conditions are met. The "gain realized" is
the difference between the amount in Brazilian currency realized on the sale
or exchange and the acquisition cost, measured in Brazilian currency without
any correction for inflation, of the shares sold. The "gain realized" as a
result of a transaction with respect to shares registered as an investment
with the Central Bank of Brazil (and not subject to the Annex IV Regulations)
will be calculated based on the foreign currency amount registered with the
Central Bank of Brazil. There can be no assurance that the current
preferential treatment for holders of ADSs and non-Brazilian holders of
Preferred Shares under the Annex IV Regulations will not be changed.
Reductions in the tax rate provided for by Brazil's tax treaties do not apply
to tax on gains realized on sales or exchanges of Preferred Shares.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Any gain on the sale or assignment
of preemptive rights relating to the Preferred Shares by the Depositary will
not be subject to Brazilian taxation.
DISTRIBUTIONS OF INTEREST ON NET WORTH
In accordance with Law No. 9,249, dated December 26, 1995, Brazilian
corporations may make payments to shareholders characterized as distributions
of interest on the Company's net worth. Such interest is limited to the
Federal Government's long-term interest rate (the "TJLP") as determined by the
Central Bank of Brazil from time to time (10.63% per annum for the three month
period starting June 1, 1998), and cannot exceed the greater of (i) 50% of net
income (before taking such distribution and any deductions for income taxes
into account) for the period in respect of which the payment is made or (ii)
50% of retained earnings.
Distributions of interest on net worth in respect of the Preferred Shares
paid to shareholders who are either Brazilian residents or non-Brazilian
residents, including holders of ADSs, are subject to Brazilian withholding tax
at the rate of 15% (except for interest due to the Federal Government, which
is exempt from tax withholding) and shall be deductible by the Registrant for
purposes of the Corporate Income Tax ("IRPJ") and Social Contribution on
Profit ("CSLL") (both of which are levied on the Company's profits) as long as
the payment of a distribution of interest is approved in the Registrant's
annual shareholders' meeting. The amount of distributions of interest on net
worth will be determined by the Board of Directors of the Registrant. No
assurance can be given that the Board of Directors of the Registrant will not
determine that future distributions of profits will be made by means of
interest on net worth instead of by means of dividends.
Under Brazilian law and regulations, the amount paid to shareholders as
interest on net worth (net of any withholding tax) may be treated as payment
in lieu of the Mandatory Dividend and Preferred Dividend (as defined under
"Description of Securities to be Registered--Capital Stock--Dividends"). In
addition, any Brazilian corporation distributing interest on net worth is
obligated to distribute to shareholders an amount sufficient to ensure that
the net amount received (after payment of withholding taxes) is at least equal
to the Mandatory Dividend.
Distributions of interest on net worth in respect of the Preferred Shares,
including to holders of ADSs, may be converted into U.S. dollars and remitted
outside of Brazil to U.S. holders, subject to relevant exchange restrictions.
See "Description of Securities to be Registered--Capital Stock--Payment of
Dividends" and "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
OTHER BRAZILIAN TAXES
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a non-
Brazilian holder except for gift and inheritance taxes levied by
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some States in Brazil on gifts made or inheritances bestowed by individuals or
entities not resident or domiciled in Brazil or in the relevant State to
individuals or entities that are resident or domiciled within such State in
Brazil. There are no Brazilian stamp, issue, registration, or similar taxes or
duties payable by holders of Preferred Shares or ADSs.
Pursuant to Decree 2,219, dated May 2, 1997, a financial transaction tax
(the "IOF") may be imposed on the conversion into Brazilian currency of the
proceeds of a foreign investment in Brazil (including investments in Preferred
Shares and ADSs and investments made under the Annex IV Regulations) and may
also be imposed upon the conversion of Brazilian currency into foreign
currency (e.g., for purposes of paying dividends and interest). The IOF tax
rate is currently 0%. Although the Minister of Finance has the legal power to
increase the rate to a maximum of 25%, any such increase will be applicable
only to transactions occurring after such increase becomes effective.
On January 24, 1997, a temporary tax was enacted. The Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which was created by
Constitutional Amendment No. 12 of August 16, 1996 and regulated by Law No.
9,311 of October 24, 1996, is levied on debits on bank accounts and certain
other payments made by a bank, at a rate of 0.2%, which may be raised at any
time to 0.25%. The CPMF Tax was initially scheduled to be collected until
February 22, 1998; the CPMF Tax was subsequently extended until January 27,
1999 by Law No. 9,539 of December 12, 1997.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder who qualifies under the Annex IV Regulations and obtains registration
with the CVM, or by the Depositary representing such holder, is eligible for
registration with the Central Bank of Brazil; such registration (the amount so
registered is referred to as "Registered Capital") allows the remittance
outside Brazil of foreign currency, converted at the Commercial Market Rate,
acquired with the proceeds of distributions on, and amounts realized with
respect to disposition of, such Preferred Shares. The Registered Capital for
each Preferred Share purchased in the form of an ADS, or purchased in Brazil,
and deposited with the Depositary in exchange for an ADS, will be equal to its
purchase price (in U.S. dollars) to the purchaser. The Registered Capital for
a Preferred Share that is withdrawn upon surrender of an ADS will be the U.S.
dollar equivalent of (i) the average price of the Preferred Share on the
Brazilian stock exchange on which the greatest number of Preferred Shares was
sold on the day of withdrawal, or (ii) if no Preferred Shares were sold on
that day, the average price on the Brazilian stock exchange on which the
greatest number of Preferred Shares were sold in the fifteen trading sessions
immediately preceding such withdrawal. The U.S. dollar value of the Preferred
Shares is determined on the basis of the average Commercial Market Rates
quoted by the Central Bank of Brazil on such date (or, if the average price of
Preferred Shares is determined under clause (ii) of the preceding sentence,
the average of such average quoted rates on the same fifteen dates used to
determine the average price of the Preferred Shares).
A non-Brazilian holder of Preferred Shares may experience delays in
effecting such registration, which may delay remittances abroad. Such a delay
may adversely affect the amount, in U.S. dollars, received by the non-
Brazilian holder.
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Registration Statement, and changes to such
law subsequent to the date of this Registration Statement may affect the tax
consequences described herein. This summary describes the principal tax
consequences of the ownership and disposition of Preferred Shares or ADSs, but
it does not purport to be a comprehensive description of all of the tax
consequences that may be relevant to a decision to hold or dispose of
Preferred Shares or ADSs. This summary applies only to purchasers of Preferred
Shares or ADSs who will hold the Preferred Shares or ADSs as capital assets
and does not apply to special classes of holders such as dealers in securities
or currencies, holders whose functional currency is not the U.S. dollar,
holders of 10% or more of the shares of the Registrant, tax-exempt
organizations, financial institutions, holders liable for the alternative
minimum tax, securities traders who
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elect to account for their investment in Preferred Shares or ADSs on a mark-
to-market basis, and persons holding Preferred Shares or ADSs in a hedging
transaction or as part of a straddle or conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under foreign,
state and local laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen
or resident of the United States of America, (ii) that is a corporation
organized under the laws of the United States of America or any state thereof,
or (iii) that is otherwise subject to U.S. federal income taxation on a net
basis with respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
TAXATION OF DIVIDENDS
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Registrant as a dividend to the extent that
such distribution is paid out of the Registrant's current or accumulated
earnings and profits ("e&p"), as determined for U.S. federal income tax
purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Registrant's e&p, it will be treated as a non-taxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS (or
Preferred Shares, as the case may be), and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld
on the amount distributed and the amount of a distribution paid in reais will
be measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian,
or by a U.S. holder in the case of holders of Preferred Shares. If the
Custodian or U.S. holder, in the case of a holder of Preferred Shares, does
not convert such reais into U.S. dollars on the date it receives them, it is
possible that the U.S. holder will recognize foreign currency loss or gain,
which would be ordinary loss or gain, when the reais are converted into U.S.
dollars. Dividends paid by the Registrant will not be eligible for the
dividends received deduction allowed to corporations under the Code.
Distributions out of e&p with respect to the ADSs generally will be treated
as dividend income from sources outside of the United States and generally
will be treated separately along with other items of "passive" (or, in the
case of certain U.S. holders, "financial services") income for purposes of
determining the credit for foreign income taxes allowed under the Code.
Subject to certain limitations, the Brazilian withholding tax paid in
connection with any distribution with respect to the ADSs may be claimed as a
credit against the U.S. federal income tax liability of a U.S. holder if such
U.S. holder elects for that year to credit all foreign income taxes, or such
Brazilian withholding tax may be taken as a deduction. Under new rules enacted
by Congress in 1997 and other guidance recently released by the U.S. Treasury,
foreign tax credits will not be allowed for withholding taxes imposed in
respect of certain short-term or hedged positions in securities or in respect
of arrangements in which a U.S. holder's expected economic profit, after non-
U.S. taxes, is insubstantial. U.S. holders should consult their own tax
advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Registrant generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or non-resident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S.
federal income tax on gain realized on the sale or other disposition of ADSs,
as discussed below.
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TAXATION OF CAPITAL GAINS
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but
not distributed by the Custodian prior to the disposition) and the U.S.
holder's tax basis in the ADS. Such gain or loss generally will be subject to
U.S. federal income tax and will be treated as capital gain or loss. Under
recently enacted legislation, long-term capital gains recognized by an
individual holder generally are subject to a maximum rate of 20 percent in
respect of property held for more than one year, effective for amounts
properly taken into account on or after January 1, 1998. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S.
holder on a sale or disposition of ADSs generally will be treated as U.S.
source income. Consequently, in the case of a disposition of Preferred Shares
in Brazil (which, unlike a disposition of ADSs, would be taxable in Brazil),
the U.S. holder might not be able to use the foreign tax credit for Brazilian
tax imposed on gain.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder
of a trade or business in the United States, or (ii) such holder is an
individual who is present in the United States of America for 183 days or more
in the taxable year of the sale and certain other conditions are met.
U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally
will be exempt from information reporting and backup withholding under current
law but a non-U.S. holder may be required to establish its non-U.S. status in
order to claim such exemption.
ITEM 8: SELECTED FINANCIAL DATA
GENERAL
The following table presents selected financial information for the Company
as of and for the periods indicated. The information as of December 31, 1996
and 1997 and for the three year period ended December 31, 1997 is derived from
and should be read in conjunction with, and is qualified in its entirety by
reference to, the Consolidated Financial Statements and the Notes thereto
included elsewhere in this Registration Statement. These Consolidated
Financial Statements have been audited by KPMG Peat Marwick, independent
auditors, and their report on such Consolidated Financial Statements appears
elsewhere in this Registration Statement. The Consolidated Financial
Statements are prepared in accordance with Brazilian GAAP, which differ in
certain material respects from generally accepted accounting principles in the
United States ("U.S. GAAP"). See Note 32 to the Consolidated Financial
Statements for a summary of the differences between Brazilian GAAP and U.S.
GAAP as of and for the years ended December 31, 1996 and 1997. All other
selected financial information has been derived from the Company's accounting
records.
The Consolidated Financial Statements present the financial condition and
results of operations of the Registrant and its subsidiaries, Telesp and CTBC.
The portion of the consolidated equity and net income of Telesp and CTBC
attributable to shareholders of Telesp and CTBC other than Telebras at
December 31, 1996 and 1997, and for each of the years in the three-year period
ended December 31, 1997 is reflected as "minority interests" in the
Consolidated Financial Statements. At December 31, 1997, such minority
shareholders directly and indirectly owned 28.6% and 30.2% of the share
capital of Telesp and CTBC, respectively.
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Registrant and its subsidiaries, Telesp and
CTBC, as continuing operations and the cellular telephone business as
discontinued operations for all periods. The assets and liabilities of the
cellular telephone business are presented as net assets of discontinued
operations.
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The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. See Note 31 to the Consolidated
Financial Statements. The assets and liabilities of the cellular telephone
business were transferred from Telesp to Telesp Celular S.A. at their indexed
historical cost. The Consolidated Financial Statements are not necessarily
indicative of the financial position and results of operations that would have
occurred for the three-year period ended December 31, 1997 had the fixed-line
telecommunications businesses of the subsidiaries Telesp and CTBC been
separate legal entities during such period. See "Description of Business--
Background," "--The Company" and Notes 1, 2 and 31 to the Consolidated
Financial Statements.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from Telesp.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, interest income and expense
relating to the cellular telecommunications business could not be identified
and, consequently, income from discontinued operations is presented before
unallocated interest income/expense and income tax expense. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations for years ended December 31, 1995, 1996 and 1997--
Allocated and unallocated interest expense and unallocated interest income."
Certain of the constant real-denominated information herein has been
translated into U.S. dollars using the December 31, 1997 Commercial Market
Rate published by the Central Bank of Brazil of R$1.1164 to US$1.00. These
translations are presented solely for the convenience of the reader and should
not be construed as implying that local currency amounts represent, or could
have been, or could be, converted into U.S. dollars at such rates or any rate.
The Consolidated Financial Statements and, unless otherwise specified, all
financial information included in this Registration Statement, have been
restated to recognize certain effects of inflation and expressed in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected in accordance with Brazilian GAAP using the integral restatement
method (correcao integral) required by the CVM to be used for Consolidated
Financial Statements of public corporations through December 31, 1995.
Inflationary gains or losses on monetary assets and liabilities have been
allocated to their corresponding income or expense caption in the income
statement. Inflationary gains or losses without a corresponding income or
expense caption have been allocated to other net operating income. See Note 2a
to the Consolidated Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes is
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its Consolidated Financial Statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare Consolidated Financial Statements.
If the Brazilian Institute of Accountants determines that the constant
currency method may no longer be used to prepare Consolidated Financial
Statements beginning January 1, 1998, the restated balances of nonmonetary
assets and liabilities of the Company as of December 31, 1997 will become the
new basis for accounting, and income statement items will no longer be
restated for inflation.
41
<PAGE>
SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1993 1994 1995 1996 1997 1997
---------- ---------- ---------- ---------- ---------- ----------------
(IN THOUSANDS
(IN THOUSANDS OF CONSTANT OF U.S. DOLLARS,
REAIS OF DECEMBER 31, 1997, EXCEPT PER
EXCEPT PER SHARE DATA) SHARE DATA(1))
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
BRAZILIAN GAAP
Net operating revenue
from telecommunications
services............... 2,554,725 2,852,772 2,743,902 3,710,205 4,086,668 3,660,577
Cost of services........ (1,330,632) (1,620,142) (1,835,493) (2,202,000) (2,387,337) (2,138,424)
---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ 1,224,093 1,232,630 908,409 1,508,205 1,699,331 1,522,153
Operating expenses...... (469,585) (686,716) (588,228) (606,915) (689,975) (618,035)
---------- ---------- ---------- ---------- ---------- ----------
Operating income from
continuing operations
before interest
income/expense......... 754,508 545,914 320,181 901,290 1,009,356 904,118
Allocated interest
expense(2)............. -- -- (27,651) (32,880) (19,353) (17,335)
---------- ---------- ---------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest income
(expense)(3)(4)(2)..... 754,508 545,914 292,530 868,410 990,003 886,783
Net non-operating income
(expense).............. (4,271) (16,889) (4,001) 94,716 15,233 13,645
Employees' profit
share.................. -- -- -- (32,465) (52,940) (47,420)
---------- ---------- ---------- ---------- ---------- ----------
Income from continuing
operations before
unallocated interest
income (expense), taxes
and minority
interests.............. 750,237 529,025 288,529 930,661 952,296 853,008
Income from discontinued
cellular operations
before unallocated
interest income
(expense), taxes and
minority
interests(3)(4)(2)..... -- -- 196,410 328,741 537,377 481,348
Unallocated interest
income(3)(4)(2)........ -- -- 48,585 98,405 202,751 181,611
Unallocated interest
expense(3)(4)(2)....... (265,746) (37,377) (66,234) (51,500) (3,332) (2,985)
---------- ---------- ---------- ---------- ---------- ----------
Income before taxes and
minority interests..... 484,491 491,648 467,290 1,306,307 1,689,092 1,512,982
Income and social
contribution taxes..... 409,997 (164,831) (122,354) (330,591) (528,672) (473,551)
---------- ---------- ---------- ---------- ---------- ----------
Income before minority
interests.............. 894,488 326,817 344,936 975,716 1,160,420 1,039,431
Minority interests(5)... (209,668) (82,898) (83,326) (249,855) (360,296) (322,730)
---------- ---------- ---------- ---------- ---------- ----------
Net income.............. 684,820 243,919 261,610 725,861 800,124 716,701
========== ========== ========== ========== ========== ==========
U.S. GAAP:
Income from continuing operations before unallocated
interest income (expense), income taxes and minority
interests............................................... 1,074,168 1,085,383 972,217
Income from discontinued cellular operations before
unallocated interest income (expense), income taxes and
minority interests ..................................... 334,489 537,426 481,392
Net income............................................... 714,153 918,505 822,738
Net income per thousand
shares:
Common shares-Basic(6)................................... 2.86 2.23 2.00
Common shares-Diluted(6)................................. 1.96 2.75 2.46
Preferred shares-Basic(6)................................ 2.86 2.23 2.00
Preferred shares-Diluted(6).............................. 1.96 2.75 2.46
</TABLE>
42
<PAGE>
SELECTED FINANCIAL INFORMATION--(CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1993 1994 1995 1996 1997 1997
---------- ---------- ---------- ---------- ---------- ----------------
(IN THOUSANDS
(IN THOUSANDS OF CONSTANT OF U.S. DOLLARS,
REAIS OF DECEMBER 31, 1997, EXCEPT PER
EXCEPT PER SHARE DATA) SHARE DATA(1))
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Brazilian GAAP
Property, plant and
equipment, net......... 9,835,829 11,791,280 12,056,545 12,334,860 12,589,455 11,276,832
Total assets............ 12,509,467 12,672,320 13,101,934 14,490,650 15,907,149 14,248,610
Loans and financing--
current portion........ 1,305,914 679,967 580,917 633,352 28,397 25,436
Loans and financing--non
current portion........ 1,302,284 896,591 659,116 494,106 472,599 423,324
Shareholders' equity.... 6,494,865 6,730,448 7,365,088 8,168,335 8,876,672 7,951,157
U.S. GAAP
Property, plant and equipment, net....................... 12,135,970 12,357,272 11,068,857
Total assets............................................. 14,436,069 15,829,256 14,178,839
Loans and financing--current portion..................... 608,790 484,229 433,741
Loans and financing--non current portion................. 494,106 -- --
Shareholders' equity..................................... 8,759,421 9,297,151 8,327,795
</TABLE>
<TABLE>
<CAPTION>
MAY 22, 1998
-------------
(IN THOUSANDS
OF CONSTANT
REAIS)
<S> <C>
NEW HOLDING COMPANY--BRAZILIAN GAAP SHAREHOLDERS' EQUITY(7):
Share capital.................................................... 3,238,421
Income reserves.................................................. 3,260,766
Retained earnings................................................ 1,778,980
---------
Total shareholders' equity...................................... 8,278,167
=========
</TABLE>
- --------
(1) The translation of Brazilian reais amounts into US dollar amounts is
unaudited and included solely for the convenience of readers outside of
Brazil and has been performed using the closing selling exchange rate
published by the Central Bank of Brazil of R$1.1164 to US$1.00 as of
December 31, 1997. This translation should not be construed as a
representation that Brazilian reais amounts could be converted to US
dollars at this or any other rate.
(2) Allocated interest expense represents interest expense attributable to
continuing operations. As discussed in note 3, the Company is unable to
present cellular operations as discontinued operations for 1993 and 1994.
Therefore, interest income and expense in 1993 and 1994 have been
presented as unallocated.
(3) The Company is unable to present cellular operations as discontinued
operations for 1993 and 1994. Accordingly, cellular operations results for
1993 and 1994 are included in "Operating income from continuing
operations."
(4) Unallocated interest income and expense represents interest income and
expense that could not be allocated between continuing and discontinued
operations.
(5) Minority interests represent the portion of net income attributable to
shareholders other than Telebras.
(6) Reflects net income per thousand shares of the Registrant. The Registrant
was not formed until subsequent to December 31, 1997. Accordingly, the
equity structure utilized for the earnings per share computations is that
of the Registrant as of May 22, 1998 (the date of its formation). At the
date of formation, the Registrant had 124,351,903 thousand common shares
(net of 17,128 thousand common shares in treasury) and 196,311,647
thousand preferred shares outstanding (exclusive of 13,718,350 thousand
preferred shares resulting from the settlement in April 1998 with
Telebras). See Note 32(e) to the Consolidated Financial Statements.
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings per Share." This new statement became effective for financial
statements for periods ending after December 15, 1997, and provides
computation, presentation and disclosure requirements for earnings per
share.
Since the preferred and common stockholders have different dividend, voting
and liquidation rights, Basic and Diluted earnings per share have been
calculated using the "two-class" method. The "two-class" method is an
earnings allocation formula that determines earnings per share for preferred
and common stock according to the dividends to be paid as required by the
Company's by-laws and participation rights in undistributed earnings. Basic
earnings per share is computed by dividing income available to common and
preferred shareholders, respectively, by the weighted-average number of
common and preferred shares outstanding, respectively, during the period.
The weighted-average number of Common and Preferred Shares used in computing
basic earnings per share for 1997 was 124,351,903 thousand and 196,311,647
thousand, respectively.
43
<PAGE>
As explained in Note 26 to the Consolidated Financial Statements the Company
has received expansion plan contributions from companies and individuals
wishing to be connected to the national telephone network and has also
sponsored Community Expansion Plan agreements. These activities are dilutive
in nature to the Shareholders of the Registrant, whether the shares to be
issued are those of the Subsidiaries (which will impact the minority
interest recognized) or of the Registrant itself. If subsidiary shares had
been issued historically, the reduction to net income to increase in net
earnings allocated to minority shareholders for 1996 and 1997 would have
been approximately R$84,427 thousand and R$37,922 thousand, respectively.
Earnings per share has been presented for net income only since interest
income, certain interest expense and social contribution taxes have not been
allocated between income from continuing operations and income from
discontinued operations.
(7) On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies, whereby existing shareholders received
shares in the New Holding Companies in proportion to their holdings in
Telebras. In addition to approving the allocation of assets and
liabilities to the New Holding Companies at the May 22, 1998 meeting, the
shareholders also approved a specific structure for the shareholders'
equity of each New Holding Company which included an allocation of a
portion of the retained earnings of Telebras. Consequently, the amounts of
the balances of capital, reserves and retained earnings were established.
For U.S. GAAP purposes, the "retained earnings" allocated from Telebras
would be referred to as Distributable Capital as this amount represents
capital allocated from Telebras. See Note 31 to the Consolidated Financial
Statements.
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company for the years ended December 31, 1995, 1996 and 1997
should be read in conjunction with the Consolidated Financial Statements of
the Company and the Notes thereto included elsewhere in this Registration
Statement. The Consolidated Financial Statements have been prepared in
accordance with Brazilian GAAP, which differs in certain significant respects
from U.S. GAAP. Note 32 to the Consolidated Financial Statements provides a
description of the principal differences between U.S. GAAP and Brazilian GAAP
as they relate to the Company, and a reconciliation to U.S. GAAP of net income
for the two years ended December 31, 1996 and 1997 and total shareholders'
equity as of December 31, 1996 and 1997.
FORMATION OF THE REGISTRANT AND PRESENTATION OF FINANCIAL INFORMATION
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. The restructuring of the Telebras System was
accomplished by means of a procedure under Brazilian law called cisao or
"split-up". Virtually all the assets and liabilities of Telebras were
allocated to the New Holding Companies which, together with their respective
subsidiaries, comprise (a) three regional fixed-line operators, (b) eight
regional cellular operators and (c) one domestic and international long-
distance operator. The Registrant is one of the New Holding Companies that was
formed on May 22, 1998 as part of the Breakup of Telebras. In the Breakup,
certain assets and liabilities of Telebras, including 71.4% of the total share
capital of Telesp and 69.8% of the share capital of Telesp's subsidiary CTBC,
were transferred to the Registrant.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders also
approved a specific structure for the shareholders' equity of each new holding
company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Telesp Participacoes S.A. were established. Telebras retained
within its own shareholders' equity sufficient retained earnings from which to
pay certain dividends and other amounts. Telebras allocated to each New
Holding Company the balance of its Retained Earnings in proportion to the
total net assets allocated to each such Company. This value of allocated
retained earnings does not represent the historical retained earnings of the
New Holding Companies and resulted in an increase of R$171,236,000 in relation
to the Company's historical retained earnings. See Note 31 to the Consolidated
Financial Statements. Allocated retained earnings and future retained earnings
will be the basis from which future dividends will be payable.
The Consolidated Financial Statements present the financial condition and
results of operations of the Registrant and its subsidiary, Telesp, and
Telesp's subsidiary, CTBC. The portion of the equity and net income of Telesp
and CTBC attributable to shareholders of Telesp and CTBC other than Telebras
at December 31, 1996 and 1997, and for each of the years in the three-year
period ended December 31, 1997, is reflected as "minority interests" in the
Consolidated Financial Statements. At December 31, 1997, such minority
shareholders directly and indirectly owned 28.6% and 30.2% of the share
capital of Telesp and CTBC, respectively.
44
<PAGE>
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Registrant and its subsidiaries, Telesp and
CTBC, as continuing operations and the cellular telephone business as
discontinued operations for all periods. The assets and liabilities of the
cellular telephone business are presented as net assets of discontinued
operations.
The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. The assets and liabilities of the
cellular telephone business were transferred from Telesp to Telesp Cellular at
their indexed historical cost. The Financial Statements are not necessarily
indicative of the financial position and results of operations that would have
occurred for the three-year period ended December 31, 1997 had the fixed-line
telecommunications businesses of the subsidiaries, Telesp and CTBC, been
separate legal entities during such periods. See "Description of Business--
Background," "--The Company" and Notes 1, 2 and 31 to the Consolidated
Financial Statements.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from Telesp.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, interest income and expense
relating to the cellular telecommunications business could not be identified
and, consequently, income from discontinued operations is presented before
unallocated interest income/expense and income tax expense.
In connection with the formation of the Registrant, certain assets and
liabilities of Telebras in addition to its interests in Telesp and CTBC were
spun off to the Registrant. The principal such assets and liabilities were
certain loans and other financings (which comprised substantially all the
external indebtedness of Telebras), cash and other current assets, noncurrent
assets and certain investments. See Note 31 to the Consolidated Financial
Statements, which includes a balance sheet of the Registrant. The Registrant
received R$479.9 million of Telebras indebtedness and R$729.9 million of
Telebras current assets, including R$439.2 million in cash and cash
equivalents. A substantial amount of the assets received from Telebras
(principally investment in subsidiaries) is eliminated upon consolidation.
EFFECTS OF INFLATION
In accordance with Brazilian GAAP, the Financial Statements recognize
certain effects of inflation and restate data from prior periods in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected using the integral restatement method (correcao integral), which was
required by the CVM to be used for Consolidated Financial Statements of public
corporations through December 31, 1995. In periods of inflation, monetary
assets generate inflationary loss and monetary liabilities generate
inflationary gain, due to the decline in purchasing power of the currency. In
the Consolidated Financial Statements, inflationary gains or losses on
monetary assets and liabilities have been allocated to their corresponding
income or expense captions in the income statement. Inflationary gains or
losses without a corresponding income or expense caption have been allocated
to other net operating income. See Note 2a to the Consolidated Financial
Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes is
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare Consolidated Financial Statements.
If the Brazilian Institute of Accountants determines that the
45
<PAGE>
constant currency method may no longer be used to prepare Consolidated
Financial Statements beginning January 1, 1998, the restated balances of
nonmonetary assets and liabilities of the Company as of December 31, 1997 will
become the new basis for accounting, and income statement items will no longer
be restated for inflation. See "Selected Financial Data."
Because financial information for the Company is presented in constant
currency, reported revenues reflect average real rates (i.e., nominal rates as
restated in constant currency in accordance with variations in the applicable
index) rather than nominal rates. Inflation results in decreases in real rates
to the extent that nominal rate increases fail to keep pace with the rate of
inflation. See "Description of Business--Rates."
POLITICAL, ECONOMIC, REGULATORY AND COMPETITIVE CONSIDERATIONS
The following discussion should be read in conjunction with the "Description
of Business" section included elsewhere in this Registration Statement. As set
forth in greater detail below, the Company's financial condition and results
of operations are significantly affected by Brazilian telecommunications
regulation, including regulation of tariffs. See "Description of Business--
Regulation of the Brazilian Telecommunications Industry." The Company's
financial condition and results of operations also have been, and are expected
to continue to be, affected by the political and economic environment in
Brazil. See "'Description of Business-- Brazilian Political Environment" and
"--Brazilian Economic Environment." In particular, the Company's financial
performance will be affected by (i) national economic growth and its impact on
demand for telecommunications services, (ii) the cost and availability of
financing and (iii) the exchange rates between Brazilian and foreign
currencies. In addition, the Presidential and Congressional elections to be
held in October 1998 could have a significant impact on whether the economic
stabilization and liberalization policies of the current administration can or
will be sustained following the elections.
In April and May 1997, a tariff rebalancing was implemented pursuant to
which certain rates were adjusted and the percentage of revenues retained by
the fixed-line companies for domestic and international long distance calls
pursuant to the division of revenues system in place prior to April 1998 was
lowered. The principal rate increases occurred with respect to monthly
subscription charges and local measured service charges. These increases were
partially offset by a decrease in domestic long distance and international
long distance rates. The monthly subscription charge increased from R$3.73 to
R$13.82 and the local measured service charge increased from R$0.05 per pulse
to R$0.08 per pulse. Average domestic long-distance and international long-
distance rates were reduced by approximately 16.7% and 17%, respectively. If
the tariff rebalancing had been effective as of January 1, 1997, the
composition of the Company's net operating revenues would have been
significantly affected and its total net operating revenues may have been
higher. Pro forma information reflecting the April and May 1997 rate changes
as if they had been in effect from January 1, 1997 has not been presented
because management believes that it is not possible to quantify with any
reasonable degree of certainty the influence on the volume of telephone use
that would have been caused by such changes in the first quarter of 1997.
Until April 1, 1998, revenues for fixed-line domestic and international
long-distance calls were divided between Embratel and the regional fixed-line
companies. Under this system, the Company and each regional fixed-line company
billed its customers for all domestic and international long-distance
telephone calls and retained a fixed percentage of the revenue, transferring
the remainder of the revenue to Embratel. The fixed percentage varied by
regional fixed-line company. As of March 31, 1998, the regional fixed-line
companies transferred an average of 33% of the total revenue for such calls to
Embratel.
As part of the liberalization of the Brazilian telecommunications sector,
this revenue-sharing system was eliminated as of April 1, 1998. Under the new
system, Embratel receives 100% of the revenues from domestic and international
long distance calls but must pay certain per-minute interconnection charges to
the Company and the other regional fixed-line companies for connection to and
use of their networks. In addition, until June 30, 2001, Embratel must pay a
supplemental per-minute charge for such interconnection, the Parcela Adicional
Temporaria (the "PAT"). The Company does not expect that implementation of
this new system will have a material impact on its net income. However, it is
expected that the allocation to Embratel of 100% of the
46
<PAGE>
revenues generated by fixed-line domestic and international long distance
calls will cause certain operating revenues to decrease. This decrease is
expected to be offset by increased revenues resulting from the network usage
charges and PAT paid to the Company by Embratel.
Following the privatization of the telecommunications sector and, provided
that the obligations of the General Plans on Universal Service and Quality of
Service are met, the Company, currently the exclusive provider of local and
intra-state intra-regional long-distance service in the region, will be
authorized to offer interstate intra-regional long-distance service, which
represents a significant expansion of the services the Company may offer, and
the Company will face competition. Embratel and a new operator will be
authorized to provide local service beginning December 31, 2003 and December
31, 2002, respectively. Embratel will also be authorized to provide intra-
state, inter-regional long-distance service and two new licenses will be
granted to up to two new entrants to provide intra-regional long-distance
service. Beginning in 2002, the Company may face an unlimited number of
competitors in local and intra-regional long-distance, and it may itself seek
a license to provide inter-regional and international long-distance service.
The Company anticipates that, as a consequence of the competition, rates may
decline. The exact identity of new entrants, the scope of increased
competition and any adverse effects on the Company's results and market share
will depend on a variety of factors that cannot now be assessed with precision
and that are beyond the Company's control. See "Description of Business--
Competition."
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURE
The Company's financial condition and results of operations may be affected
by changes in foreign currency exchange rates (primarily the U.S. dollar/real
rate) and market rates of interest (primarily the London Interbank Offered
Rate (LIBOR) and medium-and long-term U.S. interest rates).
The principal foreign exchange risk faced by the Company arises from the
excess of interest-bearing foreign currency liabilities over foreign currency
income generating assets. At December 31, 1997, the Company had R$501 million
of financial liabilities (primarily long-term bank debt) denominated in
foreign currencies (primarily U.S. dollars (71.5%)). The Company's revenues
are earned almost entirely in reais and the Company has no material dollar-
denominated assets. During the three years ended December 31, 1997, any losses
arising from the devaluation of the real against the U.S. dollar were more
than offset by net inflationary gains on monetary assets and liabilities.
Should the Company cease using the constant currency method of accounting in
the future, such inflationary gains would no longer be recognized. The Company
does not hedge its foreign currency exposure and, accordingly, any decrease in
the value of the real relative to the dollar could have a material adverse
effect on the Company's results of operations.
The Company's financial condition and results of operations may also be
affected by changes in market rates of interest (primarily LIBOR). The Company
is exposed to interest rate risk as a consequence of its floating rate
interest earning assets. At December 31, 1997, all of the Company's interest
bearing liabilities bore interest at fixed rates. The Company has not entered
into derivative contracts or made other arrangements to hedge against this
risk. Accordingly, should market interest rates rise (principally LIBOR), the
Company's financing expenses will increase.
YEAR 2000 COMPLIANCE
Year 2000 compliance is the ability of computer hardware and software to
respond to the problems posed by the fact that some computer programs have
traditionally used two digits rather than four to define the applicable year.
As a consequence, any of the Company's computer programs that have date-
sensitive software may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a system failure or miscalculations causing
disruption of operations, including a temporary inability to process
transactions, send invoices or engage in normal business activities.
At the beginning of 1997 the Company began to address the year 2000 problem.
The Company has identified the hardware and software that could be affected by
the year 2000 problem and is in the process of
47
<PAGE>
identifying and addressing potential problems. Specifically, the Company
identified and diagnosed the year 2000 problem in all of the Company's 937
central switching centers, has completed an inventory of the Company's 13,000
terminals (including 8,000 microprocessors), and is in the process of
diagnosis, after completing identification, of the Company's 27,000 computer
programs and 13 million lines of code. The Company has identified 697
switching centers and 5,400 programs that do not need to be adapted. The
Company expects its switching centers to be year 2000 compliant by September
1999. The Company expects its computer terminals and computer programs to be
Year 2000 compliant by December 1998.
The Company has contracted third party service providers who work together
with Company employees to address the year 2000 problem. The Company has
established executive and technical committees to oversee year 2000 compliance
and report monthly to the executive officers. The Company's information
services department coordinates the Company's efforts, including the hiring of
third parties. The Company estimates that to achieve year 2000 compliance, the
Company will spend approximately R$11.45 million on its information systems,
including the hiring of third parties, and approximately R$31 million on its
telecommunications hardware and software. The Company is in the process of
formulating contingency plans in collaboration with the Company's primary
suppliers of telecommunications equipment. Although the Company expects to be
fully year 2000 compliant by September 1999, the Company is still in the
process of adapting and implementing solutions to address the year 2000
problem and can give no assurance that the business and financial condition of
the Company will not be materially affected.
The Company may also be affected by year 2000 problems to the extent that
other entities not affiliated with the Company, including government entities
and businesses, are unsuccessful in addressing this issue. The Company depends
primarily on large multinational suppliers for its telecommunications products
and computer services. The majority of the Company's suppliers, however, have
formally advised the Company that they expect to be year 2000 compliant by
September 1999.
As of August 30, 1998, the Company had not determined its most probable
worst case scenarios in relation to the year 2000 problem. The Company is
arranging a plan with its suppliers to have around-the-clock technical support
provided jointly by employees of the Company and of its suppliers during the
period of the turn of the millennium.
CVM Instruction 276, which was issued on May 8, 1998, requires all Brazilian
publicly-held companies to have addressed the Year 2000 problem by December
31, 1998. Unless a discretionary extension is granted by the CVM, failure to
have addressed the year 2000 problem by the CVM's deadline could result in the
imposition of fines of R$500 per day. The Company has not requested an
extension of the deadline imposed by CVM Instruction 276 but it may do so in
the future.
48
<PAGE>
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997
The following table sets forth, for each of the years in the three-year
period ended December 31, 1997, certain components of the Company's net
income, the percentage of gross operating revenues represented by each
component and the percentage increase (decrease) thereof during the three year
period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, % CHANGE
------------------------------------------------------------- -------------------------
1995 % 1996 % 1997 % 1995 V. 1996 1996 V. 1997
------------ ----- ------------ ----- ------------ ----- ------------ ------------
(IN THOUSANDS OF REAIS EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gross operating
revenues:
Local services:
Monthly charges........ R$ 397,397 10.7 R$ 660,037 13.3 R$ 985,928 18.1 66.1 49.4
Measured service....... 730,479 19.7 1,063,738 21.4 1,355,632 24.9 45.6 27.4
Public telephones...... 107,581 2.9 133,270 2.7 174,216 3.2 23.9 30.7
Other.................. 74,111 2.0 105,242 2.1 121,500 2.2 42.0 15.4
------------ ----- ------------ ----- ------------ ----- ------- -----
Total................. 1,309,568 35.4 1,962,287 39.4 2,637,276 48.5 49.8 34.4
------------ ----- ------------ ----- ------------ ----- ------- -----
Non-local services:
Interurban............. 1,813,416 49.0 2,046,021 41.1 1,697,626 31.2 12.8 (17.0)
International.......... 257,496 7.0 260,943 5.2 192,335 3.5 1.3 (26.3)
------------ ----- ------------ ----- ------------ ----- ------- -----
Total................. 2,070,912 55.9 2,306,964 46.4 1,889,961 34.8 11.4 (18.1)
------------ ----- ------------ ----- ------------ ----- ------- -----
Data transmission...... 192,555 5.2 225,823 4.5 170,344 3.1 17.3 (24.6)
Network services....... 74,384 2.0 429,700 8.6 668,839 12.3 477.7 55.7
Other.................. 57,543 1.6 52,059 1.1 69,840 1.3 (9.5) 34.2
------------ ----- ------------ ----- ------------ ----- ------- -----
Total gross operating
revenue................ 3,704,962 100.0 4,976,833 100.0 5,436,260 100.0 34.3 9.2
Value added and other
taxes................. (919,523) (24.8) (1,212,111) (24.4) (1,298,722) (23.9) 31.8 7.1
Discounts.............. (41,537) (1.1) (54,517) (1.1) (50,870) (0.9) 31.2 (6.7)
------------ ----- ------------ ----- ------------ ----- ------- -----
Net operating revenue... 2,743,902 74.1 3,710,205 74.6 4,086,668 75.2 35.2 10.1
------------ ----- ------------ ----- ------------ ----- ------- -----
Cost of services:
Depreciation and
amortization.......... (1,101,913) (29.7) (1,223,573) (24.6) (1,274,710) (23.5) 11.0 4.2
Personnel.............. (454,953) (12.3) (504,810) (10.1) (488,611) (9.0) 11.0 (3.2)
Materials.............. (53,513) (1.4) (81,887) (1.7) (67,540) (1.2) 53.0 (17.5)
Services............... (215,491) (5.8) (366,802) (7.4) (528,482) (9.7) 70.2 44.1
Other:
Rent and insurance.... (7,832) (0.6) (18,602) (0.9) (21,649) (0.8) 137.5 16.4
Taxes................. (1,710) (0.1) (6,211) (0.3) (6,091) (0.2) 263.2 (1.9)
Miscellaneous......... (81) -- (115) -- (254) -- 42.0 120.9
------------ ----- ------------ ----- ------------ ----- ------- -----
Total cost of
services........... (1,835,493) (49.5) (2,202,000) (44.3) (2,387,337) (43.9) 20.0 8.4
------------ ----- ------------ ----- ------------ ----- ------- -----
Gross profit............ 908,409 24.5 1,508,205 30.3 1,699,331 31.3 66.0 12.7
Operating expenses:
Selling expense........ (209,672) (5.7) (250,307) (5.0) (331,162) (6.1) 19.4 32.3
General and
administrative
expense............... (643,163) (17.4) (585,468) (11.8) (580,918) (10.7) (9.0) (0.8)
Other net operating
income................ 264,607 7.1 228,860 4.6 222,105 4.1 (13.5) (3.0)
------------ ----- ------------ ----- ------------ ----- ------- -----
Total operating
expenses............. (588,228) (15.9) (606,915) (12.2) (689,975) (12.7) 3.2 13.7
------------ ----- ------------ ----- ------------ ----- ------- -----
Operating income before
interest .............. 320,181 8.6 901,290 18.1 1,009,356 18.6 181.5 12.0
Net non-operating income
(expense).............. (4,001) (0.1) 94,716 1.9 15,233 0.3 2,467.3 (83.9)
Employees' profit
share.................. -- -- (32,465) (0.7) (52,940) (1.0) -- 63.1
Income from discontinued
cellular operations
before interest, tax
and minority
interests.............. 196,410 5.3 328,741 6.6 537,377 9.9 67.4 63.5
Unallocated interest
income................. 48,585 1.3 98,405 2.0 202,751 3.7 102.5 106.0
Allocated and
unallocated interest
expense(1)............. (93,885) (2.5) (84,380) (1.7) (22,685) (0.4) (10.1) (73.1)
Income before taxes and
minority interests..... 467,290 12.6 1,306,307 26.2 1,689,092 31.1 179.5 29.3
Income and social
contribution taxes..... (122,354) (3.3) (330,591) (6.6) (528,672) (9.7) 170.2 59.9
------------ ----- ------------ ----- ------------ ----- ------- -----
Income before minority
interests.............. 344,936 9.3 975,716 19.6 1,160,420 21.3 182.9 18.9
Minority interests...... (83,326) (2.2) (249,855) (5.0) (360,296) (6.6) 199.9 44.2
------------ ----- ------------ ----- ------------ ----- ------- -----
Net income.............. 261,610 7.1 725,861 14.6 800,124 14.7 177.5 10.2
============ ===== ============ ===== ============ ===== ======= =====
</TABLE>
- --------
(1)In the Consolidated Financial Statements, allocated and unallocated
interest expense are presented separately.
49
<PAGE>
GROSS OPERATING REVENUES
The Company generates operating revenue from (i) local services, including
monthly charges, measured service and public telephones, (ii) non-local
services, including interurban service (which includes both intra-regional
long-distance and interregional long-distance) and international long-distance
service, (iii) network services, including interconnection and leasing high-
capacity lines, and (iv) other services. Operating revenues are offset by
discounts to customers and by value added and other taxes.
Gross operating revenues increased by 9.2% to R$5,436 million in 1997 from
R$4,977 million in 1996, which in turn represented a 34.3% increase from
R$3,705 million in 1995. The growth in revenues in the three-year period was
principally due to increases in the average number of lines in service,
increases in charges for local services and increased interconnection revenues
due to growth of cellular services using the Company's network. Average lines
in service increased by 10.1% to 5,268 thousand lines in 1997 from 4,784
thousand lines in 1996, which in turn represented a 9.7% increase from 4,363
thousand lines in 1995.
The structure of tariffs has changed substantially as part of a tariff
rebalancing process designed to eliminate cross-subsidies from long-distance
services to local services. Effective in May 1997, the rate structure was
modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription, and lower charges for long-distance
services. Effective in January 1996, rates for all services were increased in
nominal terms, primarily to compensate for accumulated effects of inflation,
with the largest increases for local rates.
Local services. Gross operating revenues from local services increased by
34.4% to R$2,637 million in 1997 from R$1,962 million in 1996, which in turn
represented a 49.8% increase from R$1,310 million in 1995. The increase over
the three-year period primarily reflects increased monthly subscription
revenues associated with increases in the number of lines in service and
tariff increases as well as increased measured service revenues associated
with tariff increases. These increases were partly offset in 1997 by a decline
in the overall volume of local calls.
Monthly subscription revenues increased by 49.4% to R$986 million in 1997
from R$660 million in 1996, which in turn represented an increase of 66.1%
from R$397 million in 1995. The monthly subscription charge increased,
effective January 1, 1996, by 511.5% for residential customers, 80.6% for
nonresidential customers and 87.2% for customers using PBX systems. Effective
May 1, 1997, monthly subscription charges increased by a further 270.5% for
residential customers, 59.2% for nonresidential customers and 59.3% for
customers using PBX systems.
Measured service revenues increased by 27.4% to R$1,356 million in 1997 from
R$1,064 million in 1996, which in turn represented a 45.6% increase from R$730
million in 1995. The price per pulse increased by 89.5% effective January 29,
1996, and by 61.1% effective April 4, 1997. The increase in measured service
revenue from 1996 to 1997 due to the tariff increase was partially offset by a
decrease in overall local volume. Local volume decreased by 3.5% to 23,463
million pulses in 1997 from 24,317 million pulses in 1996, which in turn
represented a 4.1% increase from 23,362 million pulses in 1995. The growth
reflects primarily increases in the number of lines in service and tariff
increases. Overall local volume decreased 3.5% in 1997 compared to 1996
largely due to higher tariffs offsetting the increase in the number of lines
in service. Overall local volume increased, however, by 4.1% in 1996 compared
to 1995. Usage per line remained relatively stable over the three year period
with average pulses per line reaching 4,454, 5,083 and 5,355 in 1995, 1996 and
1997 respectively. Management does not anticipate further large increases in
local rates in the future.
Non-local services. Non-local services consist of interurban (intra-regional
long-distance and interregional long-distance) calls and international long-
distance calls. Interurban calls include intra-regional and interregional
long-distance calls. For intra-regional long-distance calls, the Company
carries the calls entirely over its own network and receives 100% of the call
revenue. For interregional and international long-distance calls, the Company
delivers the calls to Embratel, generally at a local switching center, and
Embratel transports the call for the bulk of the call distance over its
network. For such calls, the Company bills the customer for the full
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<PAGE>
retail price of the call and pays a fixed percentage of the call revenue to
Embratel. For accounting purposes, the Company books only its percentage of
the revenue attributable to such calls.
Gross revenues from non-local services declined from 1996 to 1997. This
decline was largely due to reductions in tariffs for intra-regional,
interregional and international long-distance calls, a reduction in the fixed
percentage of interregional and international long-distance call revenue
retained by the Company and a change in the billing structure for such calls
whereby calls were billed in 6-second increments rather than whole minute
increments. The decrease was offset in part by a 9.45% increase in the volume
of intra-regional and interregional long-distance calls to 9,875 million
minutes in 1997 from 9,022 million minutes in 1996. The average basic
interurban tariff, represented by the Company's principal operating company,
Telesp, was reduced in May 1997 to R$0.25 from R$0.30 and the fixed percentage
of interregional and international long-distance revenue per call retained by
the Company was reduced from 70.48% to 53.94%. These reductions were part of
the tariff rebalancing process described above. See "--Local services," and
"Description of Business--Customer Services--Interregional and International
Service."
Of the Company's interurban revenues, revenues derived from the fixed
percentage retained for inter-regional long-distance calls declined by 20.7%
to R$666 million in 1997 from R$840 million in 1996, which in turn represented
an increase of 17.3% from R$716 million in 1995. The decrease from 1996 to
1997 occurred even as call volume increased, due to tariff reductions and the
reduction in the fixed percentage retained by the Company. Revenues from
international long-distance declined by 26.3% to R$192 million in 1997 from
R$261 million in 1996, which in turn represented an increase of 1.3% from
R$257 million in 1995. The reduction in the fixed percentage retained by the
Company's principal operating subsidiary for such calls to 53.94% has resulted
in a substantial decline in their contribution to operating revenues. For
example, interregional and international long-distance declined to 15.8% of
the Company's gross operating revenue in 1997 from 22.1% in 1996 and 26.3% in
1995. Anatel replaced the system for sharing revenues between Embratel and the
Company for inter-regional and international long-distance services on April
28, 1998. Instead of retaining a fixed percentage of revenue for all
interregional and international long-distance calls, the Company now charges
Embratel per minute of use of the Company's network. See "Description of
Business--Regulation of the Brazilian Telecommunications Industry--Rate
Regulation." There can be no assurance that the interconnection agreement with
Embratel will not result in lower revenues from carrying interregional and
international long-distance calls than under the prior regime.
Gross revenues from non-local services increased from 1995 to 1996. This
increase resulted principally from an increase in intra-regional and
interregional tariffs and growth in intra-regional and interregional call
volume. The average basic interurban tariff, represented by the Company's
principal operating subsidiary, Telesp, increased by 20% in November 1995 to
R$0.30 from R$0.25 and the volume of intra-regional and interregional calls
increased by 15.0% to 9,022 million minutes in 1996 from approximately 7,845
million minutes in 1995. In addition, revenues from international calls
increased slightly to R$261 million in 1996 from R$257 million in 1995, due
principally to an increase in the number of international minutes.
Data transmission. Gross operating revenues from data transmission decreased
by 24.6% to R$170 million in 1997 from R$226 million in 1996. This reduction
was largely due to a 42.0% reduction in rates charged for high-capacity leased
lines. The number of such lines increased during this period by 11.4% to
88,624 lines in 1997 from 79,526 in 1996. Revenues increased by 17.3% to R$226
million in 1996 from R$193 million in 1995, when tariffs were stable, due
largely to increases in the number of lines in service, which increased by
5.6% to 79,526 lines in service in 1996 from 75,287 in 1995.
Network services. The Company provides access to its network to other
telecommunications companies and leases certain network facilities to other
telecommunications and non-telecommunications companies as part of its network
services business. The network service revenues include primarily
interconnection fees from cellular companies paid for the use of the Company's
network and equipment rental fees from cellular companies, which rent
equipment from the Company, such as transmission facilities, for use in
transporting cellular calls within their own internal networks. Gross revenues
from network services increased by 55.7% to
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<PAGE>
R$669 million in 1997 from R$430 million in 1996, which in turn represented a
477.7% increase from R$74 million in 1995. The increase over the three-year
period was principally due to an increase in the use of the Company's network
by cellular operators and an expansion of the number of cellular operators.
The increase in 1996 also reflected a reclassification of interconnection fees
from other operating income in 1995 to network services revenues in 1996 and
1997. See "Description of Business--Customer Services--Network Services" and
"--Rates--Network Services." Management expects continued growth in revenues
from network services as other cellular operators grow.
Value-added taxes and other taxes. The principal taxes deducted from gross
operating revenue are a Sao Paulo state value-added tax, the ICMS, on
operating revenues from the provision of telecommunications services and
federal social contribution taxes, including the PASEP and COFINS. The Company
collects these taxes from its customers and transfers them to the appropriate
governmental activity. The rate of ICMS is 25.0%, except for international
service for which the rate was 13.0% from April 1994 to September 1996 and has
been zero since September 1996. The PASEP and COFINS aggregate 2.65% of gross
operating revenues.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) no new taxes may be applied
retroactively. At present, the Company has not sought to challenge the taxing
authorities' position with respect to application of the ICMS tax to
activation fees. If the 25% ICMS tax were applied retroactively to activation
fees earned by the Company during the last five years, it would give rise to a
maximum liability estimated at R$186.9 million. Management does not believe
that the payment of retroactive ICMS taxes is probable and, therefore, no
provision for loss with respect to retroactive application of the ICMS has
been made or is expected to be made in the Company's consolidated financial
statements. Management does not believe that application of the ICMS tax on a
prospective basis will have a material impact on the Company's results of
operations.
In 1995, the Brazilian Supreme Court ruled that certain increases in the
rate of the FINSOCIAL tax (a predecessor tax to COFINS) were unconstitutional.
As a result, the Company recorded a credit of R$52.38 million under "other net
operating income" in that year. In 1997, the Brazilian Supreme Court narrowed
its prior decision, leading the tax authorities to challenge similar 1995
credits recognized by other telecommunication companies. The authorities have
not challenged the Company's 1995 credit. If they were to do so successfully,
the Company's liability (including interest and penalties) would have amounted
to R$77 million at December 31, 1997. See Note 20 to the Consolidated
Financial Statements.
COST OF SERVICES
Costs which are incurred as part of offering the Company's
telecommunications services to the public include primarily depreciation and
amortization costs, materials and services and personnel costs. Cost of
services as a percentage of gross revenues decreased steadily over the three
year period but increased in absolute terms by 8.4% to R$2,387 million in 1997
from R$2,202 million in 1996, which in turn represented a 20.0% increase from
R$1,835 million in 1995. The following discussion addresses the principal
elements comprising cost of services.
Depreciation and amortization. Depreciation and amortization expenses
increased by 4.2% to R$1,275 million in 1997 from R$1,224 million in 1996,
which in turn represented an 11.0% increase from R$1,102 million in 1995. The
increase over the three-year period principally reflected growth of the
network. The Company's operating assets had a net book value of R$12,057
million, R$12,335 million and R$12,589 million
52
<PAGE>
at December 31, 1995, 1996 and 1997, respectively. The Company's accounting
policies and assumptions with respect to depreciation did not change during
this period.
Personnel. Personnel expenses decreased slightly by 3.2% to R$489 million in
1997 from R$505 million in 1996, while such expenses increased 11.0% from
R$455 million in 1995. The slight decrease in 1997 was principally due to a
decrease in costs associated with benefits to employees of the Company
including health and other fringe benefits and an overall decrease in wages of
4.4% when adjusted for inflation. Although the number of employees slightly
decreased in 1996 compared to 1995, such personnel reductions were
substantially outweighed by increases in wages of approximately 10%.
Materials. Expenses relating to materials decreased 17.5% to R$68 million in
1997 from R$82 million in 1996 and increased 53% from R$54 million in 1995.
The decrease in 1997 compared to 1996 related to such expenses partially
offset the increase in the cost of services in 1997 compared to 1996. The
substantial increase in material costs in 1996 compared to 1995 was due to
growth of the network and the refurbishment of public telephones.
Services. The primary components of these costs are services provided by
third parties and materials. Expenses related to services by third parties
increased 44.1% to R$528 million in 1997 from R$367 million in 1996 which, in
turn, represented a 70.2% increase from R$215 million in 1995. The increases
over the three year period were principally due to increased maintenance costs
due to network growth, refurbishment of public telephones and increased
interconnection payments primarily to cellular companies for calls originating
on the Company's network and terminating on cellular networks.
Other. Other costs of services primarily include rental and insurance
expense and municipal tax expense. Expenses relating to rental of commercial
properties and insurance payments increased 16.4% to R$21.6 million in 1997
from R$18.6 million in 1996, which in turn represented an increase of 137.5%
from R$7.8 million in 1995. Municipal tax expense was R$1.7 million, R$6.2
million and R$6.1 million in 1995, 1996 and 1997, respectively. The increase
in 1996 reflected an increase in the rate of municipal taxes and higher
vehicle registration fees.
OPERATING EXPENSES
Operating expenses increased by 13.7% to R$690 million in 1997 from R$607
million in 1996, which in turn represented an increase of 3.2% from R$588
million in 1995. The increase over the three-year period principally reflected
greater selling expense, which was partly offset by lower general and
administrative expense.
Selling expense. Selling expense increased by 32.3% in 1997 to R$331 million
from R$250 million in 1996, which in turn represented a 19.4% increase from
R$210 million in 1995. The increase in selling expense over the three-year
period primarily reflected increased third-party services costs and materials.
Third-party services expense increased by 42.9% to R$120 million in 1997 from
R$84 million in 1996, which in turn represented a 75.0% increase from R$48
million in 1995. The increase was largely associated with increased
advertising expense and commissions to sales agents. Materials expense
increased by 80.0% to R$54 million in 1997 from R$30 million in 1996, which in
turn represented a 15.4% increase from R$26 million in 1995. The increases
were due largely to costs associated with printing and selling prepayment
cards for public telephones.
Selling expense also includes provisions for past due accounts, which were
R$1.1 million, R$9.0 million and R$9.0 million in 1995, 1996 and 1997,
respectively. The 1996 increase in provisions for past due accounts reflected
growth in the Company's accounts receivable and management's estimate of the
Company's accounts receivable as to which collection was improbable.
Provisions for past due accounts did not increase in 1997.
It has been the Company's policy to maintain an allowance for past due
accounts receivable equal to management's estimate of probable future losses
on such accounts, based on historical losses on accounts receivable and the
Company's current level of overdue accounts receivable. It has been the
Company's practice to disconnect customers with accounts 90 days past due.
Prior to 1998, the Company did not experience significant losses on accounts
receivable and, accordingly, provisions to the allowance for accounts that are
not
53
<PAGE>
probable of collection were low. The low level of losses in the period from
1995 to 1997 reflected the unusual market situation prevailing in the Sao
Paulo region, where an activated fixed line has market value due to the
historically high cost of acquiring a fixed line directly from the Company and
the short supply of such lines in the Region. As a result of the high value of
a fixed line in the Region, the Company's subscribers historically have had
incentive to keep current in their payments.
In the first six months of 1998, the Company recorded R$12.2 million of
provisions to the allowance for accounts not probable of collection. This
increased level of provisions reflects the combined effect of a decrease in
the average annual income of the Company's subscribers and Brazil's economic
crisis (which has resulted in increased consumer interest rates and has
adversely affected the ability of some of the Company's customers to meet
payment obligations). In an effort to reduce the level of overdue accounts
receivable, the Company has improved collection efforts and will start
referring non-paying customers to Servico de Protecao de Credito (a credit
bureau) for further collection in November 1998. Management believes that
these measures will limit nonpayment of accounts receivable but expects that
provisions will nonetheless continue to increase in 1998.
General and administrative expense. General and administrative expense
decreased by 0.8% to R$581 million in 1997 from R$585 million in 1996, which
in turn represented a 9.0% decrease from R$643 million in 1995. The decrease
principally reflected decreased salary costs and depreciation over the three
year period in addition to a decrease in insurance and leasing costs from 1995
to 1996. Salary expense decreased by 9.4% to
R$269 million in 1997 from R$297 million in 1996, which in turn represented a
0.7% decrease from R$299 million in 1995. Depreciation decreased by 4.1% to
R$47 million in 1997 from R$49 million in 1996, which in turn represented a
37.2% decrease from R$78 million in 1995. Salary costs decreased principally
due to employee transfers and early retirement.
Other net operating income. Other net operating income slightly decreased by
3.0% in 1997 to R$222 million from R$229 million in 1996, which in turn
represented a 13.5% decrease from R$265 million in 1995. The decrease in 1997
compared to 1996 principally reflected a 59.3% decrease in revenue generated
from certain fines received from delinquent customers offset in part by an
82.2% increase in revenues from technical and administrative services.
Revenues from technical and administrative services are comprised primarily of
revenues arising from the provision of administrative and sales services to
Telesp Cellular, as well as the leasing of certain administrative services-
related equipment to Telesp Cellular. The decrease in fines from delinquent
customers resulted from a reduction mandated by Brazilian law in the amount of
such fines from 10% of the overdue account to 2%. The decrease from 1995 to
1996 was due principally to a decrease in revenue from technical and
administrative services and a decrease in fines and tax-related expenses
recovered by the Company, offset in part by a decrease in provisions for
certain contingencies and increased miscellaneous other net operating income.
See Note 7 to the Financial Statements. The 1996 decrease in revenue from
technical and administrative services principally reflected a reclassification
of interconnection fees from other operating income in 1995 to operating
income--network services in 1996 and 1997. The 1996 decrease in fines and
expenses recovered principally reflected the nonrecurrence in 1996 of a R$54
million reversal of provisions for FINSOCIAL and PASEP taxes in 1995.
ALLOCATED AND UNALLOCATED INTEREST EXPENSE AND UNALLOCATED INTEREST INCOME
As described in Note 2 to the Consolidated Financial Statements, prior to
December 31, 1997, cash and certain nonspecific debt relating to the cellular
telephone business could not be segregated. As a consequence, interest income
and certain interest expense relating to the cellular telephone business could
not be segregated and such interest income and expense are presented in the
Consolidated Financial Statements as "unallocated interest income" and
"unallocated interest expense", respectively. The following discussion
analyzes the Company's combined allocated and unallocated interest expense, as
well as its unallocated interest income.
Unallocated interest income increased by 106% to R$203 million in 1997 from
R$98 million in 1996, which in turn represented a 100% increase from R$49
million in 1995. These increases were largely due to interest income earned on
greater amounts of cash on hand. Allocated and unallocated interest expense
decreased by 73.1% to R$23 million in 1997 from R$84 million in 1996
principally reflecting a 54.5% decline in average
54
<PAGE>
indebtedness from R$924.6 million in 1996 to R$420.7 million in 1997 as a
consequence of the prepayment of certain long-term debt and other debt
financings. Allocated and unallocated interest expense decreased by 10.1% to
R$84.4 million in 1996 from R$93.9 million in 1995, principally reflecting a
24.4% decline in average indebtedness, offset in part by decreased net
inflationary gains on the Company's dollar-denominated debt.
EMPLOYEES' PROFIT SHARE
All Brazilian companies are required under Brazilian law to compensate
employees, in addition to their salary and benefits, with profit sharing. The
amount of such profit sharing is determined by negotiation between the Company
and the labor unions representing the employees. For state owned companies,
such profit sharing payments are limited to 25% of total proposed dividends.
Telebras has established two additional limits. In addition to the 25% limit
imposed on all state owned companies, companies in the Telebras System must
limit employees' share of profits to the lower of (i) the aggregate of the
employees' annual compensation and (ii) 50% the Company's net income adjusted
for dividends. Following the privatization of the Company, employee profit
share will be limited only by the 25% of dividends limit and will be
renegotiated by the Company and the unions representing its employees. The
Company's employees' profit share was R$32.5 million and R$52.9 million in
1996 and 1997, respectively. The Company did not record any employees' profit
share in 1995.
MINORITY INTERESTS
Minority interest in Telesp and in CTBC was R$83.3 million, R$249.9 million
and R$360.3 million in 1995, 1996 and 1997, respectively, reflecting 24.1%,
25.6% and 31.0% of income before minority interest, respectively. The 1997
increase in minority interest as a percentage of income before such interest
principally reflected the issuance and sale by the Company of preferred shares
to new subscribers pursuant to a system called "auto-financing." Under such
system, each new subscriber was required to invest in shares of the Company
and the proceeds from such investment were used by the Company to finance
network expansion. The Company discontinued auto-financing as of April 1997.
See "--Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
The Registrant is a holding company and its principal assets are the shares
of its operating subsidiaries. The Registrant relies largely on dividends from
its subsidiaries to meet its need for cash, including for the payment of
dividends to shareholders. Under Law No. 6,404 of December 15, 1976, as
amended (the "Brazilian Corporation Law"), dividends may be paid only out of
retained earnings or accumulated profits in any given fiscal year. See
"Description of Securities to be Registered--Capital Stock--Dividends."
Management believes that the Registrant's shareholding in Telesp and CTBC is
sufficient to allow the Registrant to control the payment of dividends by such
companies. The Registrant currently is able to nominate and elect all the
members of the boards of directors of Telesp and CTBC. However, under
Brazilian law and the regulations of the Brazilian Securities Commission,
persons holding more than 10% of the voting stock of a company (a percentage
that may decrease up to 5% in the case of listed companies) may require the
company to adopt cumulative voting. Management believes that, based on current
holdings in its operating subsidiaries, if cumulative voting were required,
the Registrant would still be able to control the payment of dividends by
Telesp and CTBC which, with respect to the Mandatory Dividend, could be
limited only under very strict circumstances. Board members, even if elected
by one specific shareholder, have fiduciary duties toward the company and all
its shareholders. The preferred shareholders and the minority voting
shareholders of Telesp and CTBC, in each case voting as a single class of such
preferred shareholders and a single class of such minority voting
shareholders, elect one member each of the Audit Committee. The remaining
members of the Audit Committee are selected by the controlling shareholder.
The Company's principal liquidity and capital resource requirements are to
finance capital expenditures and investments related to the expansion,
improvement and maintenance of its property, plant and equipment.
Historically, the Company has financed its capital expenditures and
investments primarily with internally generated funds and with proceeds from
the required sale of the Company's shares to new customers ("auto-financing").
As of April 1997 the Company discontinued autofinancing. See "Description of
Business--Rates--Local Services."
55
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The Company made capital expenditures of R$1,248.6 million, R$1,323.3
million and R$1,479.6 million in 1995, 1996 and 1997, respectively. The
principal expenditures related primarily to the expansion and modernization of
the Company's network. See "Description of Business--Capital Expenditures." In
addition, the Company paid dividends of R$135.5 million, R$220.5 million and
R$258.1 million in 1995, 1996 and 1997, respectively.
The Company's primary source of funds is cash flow generated from continuing
operations, net of taxes applicable to both continuing and discontinued
operations. Net cash flow generated from operating activities was R$1,284.3
million, R$1,342.6 million and R$2,151.3 million in 1995, 1996 and 1997,
respectively.
The Company's total indebtedness for loans and financing was R$1,127.5
million and R$501.0 million as of December 31, 1996 and 1997. The principal
categories of indebtedness at December 31, 1997 were the following:
Loans payable to Telebras (R$143.4 million). Loans payable to Telebras
arise from the onlending by Telebras of proceeds of an issue of Eurobonds
denominated in Italian Lire. The Company pays Telebras the contractual
interest rate of 13% plus an administrative fee of 1%.
Upon the Breakup of the Telebras System and the formation of the Registrant,
approximately R$6.5 million of Telesp's indebtedness, representing loans from
Telebras, became intercompany loans payable by Telesp to the Registrant.
Accordingly, these intercompany loans and the market risk and interest expense
relating to such loans will be eliminated in the preparation of the
Registrant's consolidated financial statements in the future.
In connection with the formation of the Registrant, certain assets and
liabilities of Telebras in addition to its interests in Telesp and CTBC were
spun off to the Registrant. The principal such assets and liabilities were
certain loans and other financings (which comprised substantially all the
external indebtedness of Telebras), cash and other current assets, noncurrent
assets and certain investments. See Note 31 to the Financial Statements, which
includes a balance sheet of the Registrant. The Registrant received R$479.9
million of Telebras indebtedness and R$729.9 million of Telebras current
assets, including R$439.2 million in cash and cash equivalents.
Other financing (R$357.6 million). Other financing relates to equipment
financing from Comtel Brasileira Ltda. (denominated in U.S. dollars). The
financing bears interest at 10.75% and matures in 2004. This financing is
guaranteed by Telebras. The proceeds of this financing were loaned to
Telesp Cellular.
R$126.5 million and R$346.1 million of interest and principal payments on
the Company's indebtedness as of December 31, 1997 will be due in 1999 and in
2003 and thereafter, respectively. The Company has no committed lines of
credit.
The Company anticipates that capital expenditures for the first eight months
of 1998 will be R$1,710 million, which is expected to be funded with
internally generated funds from operations. See "Description of Business--
Capital Expenditures." The Company expects to finance its capital
expenditures, debt service obligations and dividend payments from internally
generated funds and from its existing sources of debt financing.
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998 and the privatization of the
Company on July 29, 1998 constituted events of default under such credit
agreements. In addition, most of the Company's other credit agreements include
cross-default provisions and cross-acceleration provisions that would permit
the holders of such indebtedness to declare the indebtedness to be in default
and to accelerate the maturity thereof if a significant portion of the
principal amount of the Company's debt is in default or accelerated. The total
amount of the Company's outstanding debt in default or expected to be in
default is approximately R$483.5 million as of December 31, 1997. The Company
is currently in negotiations with the appropriate creditors with respect to
this indebtedness. Although none of the Company's creditors have notified
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the Company that they intend to pursue their rights and remedies with respect
to these defaults, there can be no assurance that the Company will be able to
obtain waivers or that the creditors will not exercise their rights and
remedies under the credit agreements.
RECONCILIATION TO U.S. GAAP
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
principal differences between Brazilian GAAP and U.S. GAAP as they affected
the Company's results of operations are: (i) under Brazilian GAAP, loans and
financing balances in default are not always classified as current liabilities
while under U.S. GAAP, loans and financings in default or expected to be in
default within a year of the balance sheet date are classified as current
obligations unless creditors have provided the Company waivers for such
defaults; substantially all of the Company's outstanding debt at December 31,
1997 is in default or expected to be in default as a result of its
privatization and the Breakup of the Telebras System (see "--Liquidity and
Capital Resources"); (ii) under Brazilian GAAP, interest on loans to finance
construction in progress is capitalized at the rate of 12% per annum of the
total value of construction in progress, regardless of the total amount of
interest actually incurred on such loans while under U.S. GAAP interest is
capitalized at the interest rate on the debt incurred up to the lower of the
amount of construction in progress and the total loans incurred; (iii) until
December 31, 1993 capitalized interest under Brazilian GAAP was not added to
individual assets but was capitalized separately and amortized over a time
period different from the estimated useful lives of the related assets while
under U.S. GAAP capitalized interest is added to the cost of individual assets
and is amortized over their estimated useful lives; (iv) under Brazilian GAAP
the issuance of shares of the Company to finance capital investments was
recorded at the book value of the shares while under U.S. GAAP the sale of
shares must be recorded at their market value resulting in a gain carried as
deferred income and amortized into current income on the same schedule as the
plant financed with the proceeds from the sale of the shares; (v) under
Brazilian GAAP proposed dividends are accrued for in the financial statements
in anticipation of their approval at the shareholders' meeting while under
U.S. GAAP, dividends are not accrued until they are formally declared; and
(vi) under Brazilian GAAP, the deferred tax liability arising from the
indexation of assets and liabilities for financial reporting purposes was
recorded against retained earnings while under U.S. GAAP such effects would be
charged to income and social contribution taxes in the statements of income.
Net income under U.S. GAAP was R$714.2 million and R$918.5 million in 1996 and
1997, respectively. See Note 32 to the Consolidated Financial Statements.
RECENT RESULTS
The Company has reported consolidated net operating revenues of R$2,152.1
million and consolidated net income of R$322.9 million for the six months
ended June 30, 1998. Such amounts are unaudited, have been determined in
accordance with the Brazilian Corporation Law and standards issued by the CVM
and have not been indexed for inflation occurring after December 31, 1995 or
been expressed in constant reais. Accordingly, such amounts, as well as the
six months amounts discussed in the paragraphs below, are not comparable to
the amounts included in the Consolidated Financial Statements, which have been
so indexed and expressed. See "Presentation of Information." Had consolidated
net operating revenues and consolidated net income for the six months ended
June 30, 1998 been indexed for inflation and expressed in constant reais on
the same basis as the amounts presented in the Consolidated Financial
Statements, such adjustments would have had no material effect on net
operating revenues and would have resulted in a downward adjustment of
approximately R$94 million to net income (principally reflecting additional
depreciation, net of related tax effects). As measured by the IGP-M, the
cumulative rate of inflation from the period December 31, 1995 to June 30,
1998 was 20.0%.
Consolidated net operating revenue for the first six months of 1998
evidenced a slight upward trend, reflecting increasing monthly subscription
revenue of R$606.6 million associated with an increase in the number of lines
in service, as well as increasing revenue of R$467.2 million from the
Company's network service business, which was principally attributable to an
increase in the use of the Company's network by cellular operators and an
expansion of the number of cellular operators during the period.
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In the first six months of 1998, cost of services (R$1,162.0 million),
selling expense (R$155.8 million) and general and administrative expense
(R$264.0 million) evidenced a downward trend, principally due to the
renegotiation of service contracts with third parties.
Results for the first six months of 1998 are not necessarily indicative of
results for any other period or for the full year.
Management believes that the material adjustments that would be required to
reconcile the first six months net income figure given above to U.S. GAAP are
comparable in nature to those discussed in Note 32 to the Consolidated
Financial Statements except that indexation for inflation subsequent to
December 31, 1995 and through December 31, 1997 would be required under U.S.
GAAP and the cessation of indexation as from January 1, 1998 will eliminate
the need for the recognition of an additional charge to income under U.S. GAAP
for the deferred income tax effects of indexation for financial reporting
purposes.
Comparative interim period net operating revenues and net income are not
presented herein. The Registrant was not formed prior to May 22, 1998 and did
not publish interim financial results for the first half of 1997. In addition,
the Registrant's operating subsidiaries', published interim 1997 results (if
any) were for the combined cellular and fixed line entities.
As part of the privatization of the Telebras System, the Federal Government
has offered Telebras System employees the right to purchase the Federal
Government's entire holding of Telebras preferred shares and preferred shares
of each of the New Holding Companies (representing 2.18% of the outstanding
capital stock of Telebras and of each New Holding Company) at a price of
R$69.24 per lot of 13,000 shares (each a "lot" and comprised of 1,000
preferred shares of each of Telebras and the twelve New Holding Companies).
This price represents a 50% discount from the market price of 1,000 Telebras
preferred shares at the time the Federal Government authorized the plan. The
initial period during which employees could subscribe for the shares began on
August 4, 1998 and expired on September 30, 1998. On August 28, 1998, the
Federal Government extended the period for the offer to October 30, 1998. The
offer period has not been extended again and the Federal Government has not
expressed any intention to do so. Each employee has the right to purchase up
to 144 lots of 13,000 preferred shares, subject to proration if the shares are
oversubscribed.
The Federal Government has offered 7.2 million lots, or 60% of the total
number of lots (12.1 million) that would be required if every employee in the
Telebras System offered to purchase the maximum 144 lots per employee allowed.
If offers to purchase are made for more than 7.2 million lots, employees will
be allocated the available 7.2 million lots on a pro-rata basis. Accordingly,
if every employee in the Telebras System offered to purchase the maximum 144
lots, each employee would be allocated 86.4 lots (or 60% of 144). This
allocation would increase up to 144 lots as the total number of Telebras
System-wide offers to purchase declined to 7.2 million lots or less. If total
employee demand is for less than 7.2 million lots, the unsold shares will
remain with the Federal Government. The market price of 1,000 Telebras
preferred shares when the offer to employees commenced on August 4, 1998 was
R$127.20. At this date, 1,000 Telebras preferred shares was equivalent to one
lot, because the distribution of New Holding Company preferred shares in
connection with the Breakup had not occurred. The market price of one lot on
October 30, 1998, when the offer to employees terminated, was R$91.00.
The employee stock offering will have no effect on the Company's financial
statements prepared under Brazilian GAAP. For U.S. GAAP purposes only, the
employee stock offering is deemed to give rise to compensation expense to the
extent of the excess of market price of the shares purchased over the Federal
Government's price to employees. Although the Federal Government, rather than
the Company or Telebras, offered the shares to employees, under U.S. GAAP the
deemed compensation amount is "pushed down" to each of the New Holding
Companies in accordance with the number of shares purchased by each New
Holding Company and its subsidiaries' employees. The Company is not yet able
to determine the total amount of the expense that must be recognized under
U.S. GAAP because a complete count of employee subscription is not yet
available. A complete count is not available because a significant portion of
employee subscriptions for shares
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is made in paper rather than electronic form. The tabulation of such paper
subscriptions is required to be completed by November 13, 1998. Although the
total amount of the U.S. GAAP expense is not presently determinable, the
minimum amount (all of which will be recognized effective August 4, 1998) is
R$113.8 million. Effective October 30, 1998 the Company will record an
additional expense ranging from R$0 to R$28.5 million, depending on the total
number of shares above the maximum 60% allocation that the Company's employees
are able to purchase. These expenses are calculated on the assumption that
each of the Company's employees purchases the maximum 144 lots per employee.
For this actually to occur, each of the Company's employees would have to
subscribe for the maximum amount and the employee offering as a whole would
have to be sufficiently under-subscribed to allow the Company's employees to
be allocated the maximum 144 lots each. The maximum expense is calculated on
two measurement dates: (i) August 4, 1998, when it is assumed that the
Company's employees take up 86.4 lots each (or 60% of the 144 lots maximum),
which is the maximum amount that the Company's employees could purchase in the
event that the remaining Telebras System employees also seek to take up the
maximum allowable number of shares; and (ii) October 30, 1998, when it is
assumed that, based on system-wide under-subscription, the Company's employees
are allocated the remaining 57.6 lots each. The expense arising from the
August 4 measurement date will be recorded in the third quarter. The expense
arising from the October 30 measurement date will be recorded in the fourth
quarter.
The Company has been informed by Telebras that, for the Telebras System as a
whole, the maximum expense under US GAAP in connection with the employee share
offering will be R$421.6 million.
ITEM 9A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in both foreign currency
exchange rates and interest rates. The Company is exposed to foreign exchange
rate risk because certain of its costs are denominated in currencies
(primarily the U.S. dollar) other than those in which it earns revenues
(primarily the real). Similarly, the Company is subject to market risk
deriving from changes in interest rates which may affect the cost of its
financing. The Company does not use derivative instruments, such as foreign
exchange forward contracts, foreign currency options, interest rate swaps and
forward rate agreements, to manage these market risks, nor does it hold or
issue derivative or other financial instruments for trading purposes.
EXCHANGE RATE RISK
The Company has exchange rate exposure with respect to the U.S. dollar and,
to a lesser extent, other currencies. Approximately R$358 million of the
indebtedness of the Company is denominated in U.S. dollars, and approximately
R$143 million of the Company's indebtedness is indexed to the Italian Lira.
The potential immediate loss to the Company that would result from a
hypothetical 10% change in foreign currency exchange rates would be
approximately R$50 million. In addition, if such a change were to be
sustained, the Company's cost of financing would increase in proportion to the
change. This sensitivity analysis assumes an unfavorable 10% fluctuation in
all of the exchange rates affecting all the foreign currencies in which the
indebtedness described above is denominated. Since consistently and
simultaneously unfavorable movements in all relevant exchange rates are
unlikely, this assumption may overstate the impact of exchange rate
fluctuations on the Company's results of operations.
INTEREST RATE RISK
At December 31, 1997, the Company had approximately R$501 million in loans
and financing outstanding, all of which bore interest at fixed rates. The
Company invests its excess liquidity (R$858 million at December 31, 1997)
mainly in short-term instruments. The potential loss to the Company over one
year that would have resulted from a hypothetical, instantaneous and
unfavorable change of 100 basis points in the interest rates applicable to
financial assets and liabilities on December 31, 1997 would be approximately
R$9 million. The above sensitivity analyses are based on the assumption of an
unfavorable 100 basis point movement of the interest rates applicable to each
homogenous category of financial assets and liabilities and sustained over a
period of one year. A homogenous category is defined according to the currency
in which financial assets and liabilities are denominated and assumes the same
interest rate movement within each homogenous category (e.g. U.S. dollars). As
a result, the Company's interest rate risk sensitivity model may overstate the
impact of interest rate fluctuation for such financial instruments as
consistently unfavorable movements of all interest rates are unlikely. See
Note 19 to the Consolidated Financial Statements.
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ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT
BOARD OF DIRECTORS
The Registrant is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria). The Board of
Directors is comprised of four members serving for a term of three years. The
Board of Directors holds a regular meeting once a month and holds special
meetings when called by the Chairman or by two members of the Board of
Directors.
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The following are the current members of the Board of Directors and their
respective positions.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Fernando Maria Fournon Gonzalez-Barcia............................ Chairman
Fernando Xavier Ferreira.......................................... Director
Luis Eduardo Jimenez Lopez........................................ Director
Jose Joao Sottomayor Roque de Pinho............................... Director
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
Fernando Maria Fournon Gonzalez-Barcia, 40 years old, has served as Chairman
of the Board of Directors since August 1998. He served as an associate and
research professor at Polytechnic University of Madrid, a systems engineer at
the European Space Agency, a projects engineer at Ericsson S.A. and as Head of
Projects and Director of New Projects at Telefonica Internacional. Since
February 1997 he has served as chief executive officer at CRT--Companhia
Riograndense de Telecomunicacoes. In addition to his position as Chairman of
the Board of Directors of the Company, he is also a member of the Board of
Directors of Companhia Telefonica da Borda do Campo--CTBC, CRT--Companhia
Riograndense de Telecomunicacoes, Tele Leste Celular Participacoes S.A., Tele
Sudeste Celular Participacoes S.A. and Portugal Telecom. He holds a degree in
telecommunications engineering from the Polytechnic University of Madrid.
Fernando Xavier Ferreira, 49 years old, has served as a member of the Board
of Directors since September 1998. Beginning in 1971, he held various
positions at Telecomunicacoes do Parana S.A. ("Telepar"), including Vice-
President, Director of Market Relations and President. Since that time he has
served as Chairman of the Board of Directors of Telebras, Telesp and Embratel.
In February 1995, he was appointed Board Member and President of Telebras,
from March to August 1998 he served as Board Member and President of the
Registrant and from May to August 1998 he was appointed Executive President
and Board Member of Embratel. He is also a member of the Consultive Board of
ANATEL--Agencia Nacional de Telecomunicacoes, the Latin American Committee at
the New York Stock Exchange and the Global Information Infrastructure
Commission--GIIC. In September 1998, he was appointed Executive President and
Board Member of the Registrant and Tele Sudeste Celular Participacoes S.A. He
holds a degree in electrical engineering from the Catholic University of Rio
de Janeiro.
Luis Eduardo Jimenez Lopez, 43 years old, has served as a member of the
Board of Directors since August 1998. He worked in Chile at the Projects
Analysis and Evaluation Department of Banco Interamericano de Desarollo (BID)
and at the Investment Projects Analysis and Evaluation Department of
Consultoria Claudio Barriga Associados. At Banco do Chile he served as
financial projects analyst, supervisor of the Risk Analysis Department,
manager of Medium and Large Companies Accounts and account manager of the Debt
Renegociation Team. He served as administrative and financial manager of
Impresora y Comercial Publiguias S.A., a subsidiary of Telefonica de Espana
and Compania Telefonica de Chile S.A., and chief financial officer at CRT--
Companhia Riograndense de Telecomunicacoes in Brazil. He is also a member of
the Board of Directors of Companhia Telefonica da Borda do Campo--CTBC, Tele
Sudeste Celular Participacoes S.A. and Telecomunicacoes de Sao Paulo S.A.--
Telesp, the operating subsidiary of the Company. He holds a degree in agronomy
engineering, a post graduate degree in economy and a masters degree in
business administration from the Catholic University of Chile and a degree in
financial analysis from the University of Chile.
Jose Joao Sottomayor Roque de Pinho, 54 years old, has served as a member of
the Board of Directors since August 1998. He served as the representative and
director of marketing of Marconi S.A. in North and Central America through the
company CPRM North America. In addition to his position as a member of the
Board of Directors of the Company, he is President of Portugal Telecom do
Brasil and a member of the Board of Directors of Companhia Telefonica da Borda
do Campo--CTBC, Telesp Celular Participacoes S.A. and Telecomunicacoes de Sao
Paulo S.A.--Telesp (the operating subsidiary of the Company). He holds a
degree in mechanical engineering from the University of Porto--Portugal.
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BOARD OF EXECUTIVE OFFICERS
The Board of Executive Officers consists of one President and one Vice
President elected by the Board of Directors for a term of three years. An
Executive Officer may be removed from office at any time. The President must
be chosen from among the members of the Board of Directors.
The following are the Executive Officers and their respective positions. All
current members were appointed in August 1998.
<TABLE>
<CAPTION>
NAME POSITION
---- --------------
<S> <C>
Fernando Xavier Ferreira.................................... President
Manuel Ramon Garcia Garcia.................................. Vice-President
</TABLE>
Set forth below is a brief biographical description of the Executive Officer
not included above.
Manuel Ramon Garcia Garcia, 49 years old, has served as an Executive Officer
since September 1998. He served as Director of the Secondary Markets Division
at Spanish National Commission for Securities Markets between 1989 and 1993,
Director of Investments at Telefonica de Espana Pension Fund between 1993 and
1995 and Chief Financial Officer, Chief Executive Officer and Executive
President of Telefonica del Peru between 1996 and 1997. In addition to his
position as Vice President of the Company, on September 1998 he was also
appointed President of CTBC--Companhia Telefonica da Borda do Campo and
Executive Vice-President of Telecomunicacoes de Sao Paulo S.A.-- Telesp (the
operating subsidiary of the Company). He holds a degree in economics from
Universidad Conplutense de Madrid.
ITEM 11: COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1997, the aggregate amount of compensation
paid by the Registrant's subsidiaries to all directors and executive officers
of the Registrant's subsidiaries as a group was approximately R$ 1.1 million.
For the year ended December 31, 1997, the aggregate amount set aside or
accrued by the Registrant's subsidiaries to provide pension, retirement or
similar benefits for officers and directors of the Registrant's subsidiaries
was approximately R$161.6 thousand. The Registrant did not have any officers
or directors for the year ended December 31, 1997 because it was not formed
until May 22, 1998 as part of the Breakup of Telebras.
ITEM 12: OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
None.
ITEM 13: INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
None.
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PART II
ITEM 14: DESCRIPTION OF SECURITIES TO BE REGISTERED
CAPITAL STOCK
Set forth below is a brief summary of the material provisions concerning the
Preferred Shares and Common Shares, the By-laws and the Brazilian Corporation
Law. This description is qualified by reference to the By-laws, which have
been filed (together with an English translation) as an exhibit to this
Registration Statement and to the Brazilian Corporation Law. A copy of the By-
laws (together with an English translation) is available for inspection at the
principal office of the Depositary. Information on the trading market for the
Preferred Shares is set forth under "Nature of Trading Market" and information
on ownership of the Registrant's shares is set forth under "Control of
Registrant."
GENERAL
The capital stock of the Registrant is comprised of Preferred Shares and
Common Shares, all without par value. At May 22, 1998, there were 210,029,997
thousand outstanding Preferred Shares and 124,351,903 thousand outstanding
Common Shares. The Company's share capital may be increased only by
shareholder vote.
The Preferred Shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the Common Shares in the case of liquidation of the Registrant.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the Preferred Shares, may not
exceed two-thirds of the total number of shares. The Federal Government was
required by law prior to the privatization to own more than 50% of the voting
stock of the Registrant.
The majority of the members of the Board of Directors will be elected by the
controlling shareholders of Common Stock of the Registrant. Board members,
even if elected by one specific shareholder, have fiduciary duties towards the
Registrant and all its shareholders.
DIVIDENDS
Pursuant to its By-laws, the Registrant is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined below) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of Preferred Shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of Common Shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of Preferred
Shares and Common Shares. Under the Brazilian Corporation Law, a company is
permitted to suspend the Mandatory Dividend in respect of common shares and
preferred shares not entitled to a fixed or minimum dividend if its Board of
Directors and Audit Committee report to the shareholders' meeting that the
distribution would be incompatible with the financial circumstances of such
company and the shareholders ratify this conclusion at the shareholders'
meeting. In this case, (i) the Board of Directors must forward to the CVM
within five days of the shareholders' meeting an explanation justifying the
information transmitted at the meeting and (ii) the profits which were not
distributed for such reason are to be recorded as a special reserve and, if
not absorbed by losses in subsequent fiscal years, are to be paid as dividends
as soon as the financial situation of such company permits. The Preferred
Shares of the Registrant are entitled to a minimum dividend and thus the
Mandatory Dividend may be suspended only with respect to the Common Shares.
See "--Priority and Amount of Preferred Dividends." Dividends may be paid by
the Registrant out of retained earnings or accumulated profits in any given
fiscal year.
For the purposes of the Brazilian Corporation Law, accumulated profits are
defined as net income after income tax and social contribution for such fiscal
year, net of any accumulated losses from prior fiscal years and
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any amounts allocated to founders' shares, income bonds, employees' and
management's participation in a company's profits.
At each annual shareholders' meeting, the Board of Directors is required to
recommend how net profits for the preceding fiscal year are to be allocated.
Under the Brazilian Corporation Law, the Registrant is required to maintain a
statutory reserve, to which it must allocate 5% of net profits for each fiscal
year until the amount of such reserve equals 20% of the Registrant's paid-in
capital (the "Statutory Reserve"). Net losses, if any, may be charged against
the statutory reserve.
The Brazilian Corporation Law also provides for two additional discretionary
allocations of net profits that are subject to approval by shareholders at the
annual shareholders' meeting. First, a percentage of net profits may be
allocated to the contingency reserve for anticipated losses that are deemed
probable in future years (the "Contingency Reserve"). Any amount so allocated
in a prior year must be either (i) reversed in the fiscal year in which the
loss was anticipated if such loss does not in fact occur or (ii) written off
in the event that the anticipated loss occurs. Second, if the amount of
Unrealized Revenue exceeds the sum of (i) the statutory reserve, (ii) the
Contingency Reserve and (iii) retained earnings, such excess may be allocated
to the reserve (the "Unrealized Revenue Reserve"). Such allocations may not
hinder the payment of dividends on the Preferred Shares. "Unrealized Revenue"
is defined under the Brazilian Corporation Law as the sum of (i) the share of
equity earnings of affiliated companies which is not paid as cash dividends
and (ii) profits from installment sales to be received after the end of the
next succeeding fiscal year.
For the purposes of the Brazilian Corporation Law, and in accordance with
the Registrant's By-laws, the "Adjusted Net Income" is an amount equal to the
Registrant's net profit adjusted to reflect allocations to and from (i) the
Statutory Reserve; (ii) the Contingency Reserve and (iii) the Unrealized
Revenue Reserve.
The amounts available for distribution are determined on the basis of
financial statements prepared in accordance with the Brazilian Corporation
Law, which differ from financial statements, such as the Consolidated
Financial Statements included herein, that are prepared using the constant
currency method according to Brazilian GAAP.
In order to allow the payment of dividends after the Breakup, the
shareholders of Telebras approved, as a part of the Breakup, the allocation of
a proportional part of the retained earnings and reserves of Telebras
transferred to the Registrant as retained earnings of Registrant. These
earnings and reserves (which amount to R$5.040 million) are available for
payment of future dividends by the Registrant, if so decided by the
shareholders, although the Registrant is not legally obligated to do so.
PRIORITY AND AMOUNT OF PREFERRED DIVIDENDS
The Registrant's By-laws provide for a minimum yearly per share dividend for
the Preferred Shares equal to 6% of the amount obtained by dividing the total
share capital by the total number of shares of the Company. As a result of
such provision, holders of Preferred Shares are entitled to receive in any
year distributions of cash dividends prior to the holders of Common Shares
receiving any distribution of cash dividends in such year. In addition,
distributions of cash dividends in any year are made (i) first, to the holders
of Preferred Shares, up to the amount of the Preferred Dividend of the
Preferred Shares for such year, (ii) then, to the holders of Common Shares,
until the amount distributed in respect of each Common Share is equal to the
amount distributed in respect of each Preferred Share, and (iii) thereafter,
to the Common Shares and Preferred Shares on a pro rata basis. If the
Mandatory Dividend in any year is less than or equal to the Preferred Dividend
payable to the holders of Preferred Shares in such year, the holders of Common
Shares will not be entitled to receive any cash dividends from the Registrant
in such year, unless the holders of Common Shares approve dividends in excess
of the Preferred Dividend. In such circumstances, however, holders of
Preferred Shares will be entitled to the amount available for payment of
dividends up to an aggregate amount equal to the Preferred Dividend plus, in
the event the Preferred Dividend is higher than the amount available for
payment of dividends for such year, any retained earnings from previous years
may be used to make up for such shortfall. If the minimum dividend is not paid
for a period of three years, holders of Preferred Shares shall be entitled to
full voting rights until such time as the minimum dividend is paid in full for
any year.
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PAYMENT OF DIVIDENDS
The Registrant is required by law and its By-laws to hold an annual
shareholders' meeting by April 30 of each year at which, among other things,
an annual dividend may be declared by decision of the shareholders on the
recommendation of the Executive Officers, as approved by the Board of
Directors. The payment of annual dividends is based on the Financial
Statements prepared for the fiscal year ending December 31. Under the
Brazilian Corporation Law, dividends are required to be paid within 60 days
following the date the dividend is declared to shareholders of record on such
declaration date, unless a shareholders' resolution sets forth another date of
payment, which must occur prior to the end of the fiscal year in which such
dividend was declared. A shareholder has a three-year period from the dividend
payment date to claim dividends in respect of its shares, after which the
Registrant has no liability for such payment. Because the Registrant's shares
are issued in book-entry form, dividends with respect to any share are
automatically credited to the account holding such share and no action is
required on the part of the shareholder. The Registrant is not required to
adjust the amount of paid-in capital for inflation. Annual dividends may be
paid to shareholders on a pro rata basis according to the date when the
subscription price is paid to the Registrant.
Shareholders who are not residents of Brazil must register with the Central
Bank of Brazil in order for dividends, sales proceeds or other amounts with
respect to their shares to be eligible to be remitted outside of Brazil. The
Preferred Shares underlying the ADSs are held in Brazil by the Custodian, as
agent for the Depositary, which is the registered owner of the Registrant's
shares. See "--Description of American Depositary Receipts in respect of
Preferred Shares."
Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the Custodian on behalf of the Depositary, which will
then convert such proceeds into U.S. dollars and will cause such U.S. dollars
to be delivered to the Depositary for distribution to holders of ADRs. In the
event that the Custodian is unable to convert immediately the Brazilian
currency received as dividends into U.S. dollars, the amount of U.S. dollars
payable to holders of ADRs may be adversely affected by devaluations of the
Brazilian currency that occur before such dividends are converted and
remitted. Dividends in respect of the Preferred Shares paid to resident and
non-resident shareholders, including holders of ADSs, are not currently
subject to Brazilian withholding tax. See "Taxation--Brazilian Tax
Considerations."
VOTING RIGHTS
Each Common Share entitles the holder thereof to one vote at meetings of
shareholders of the Registrant. Preferred Shares do not entitle the holder to
vote except as set forth below. Holders of Preferred Shares are entitled to
attend or to address meetings of shareholders.
One of the three members of the permanent Audit Committee of the Registrant
and his or her alternate are elected by majority vote of the holders of
Preferred Shares present at the annual meeting of shareholders at which
members of the Audit Committee are elected.
Brazilian Corporation Law provides that certain non-voting shares, such as
the Preferred Shares, acquire voting rights in the event the Registrant fails
for three consecutive fiscal years to pay the Preferred Dividend to which such
shares are entitled until such payment is made.
The Preferred Shares are entitled to full voting rights with respect to (i)
the approval of any long-term contract between the Company and its affiliates,
on the one hand, and any controlling shareholder of the Company, such
shareholder's affiliates and related parties, on the other hand and (ii)
resolutions modifying certain provisions of the By-laws. The Preferred Shares
are entitled to full voting rights with respect to any resolution submitted to
the shareholders' meeting for the delisting of the Registrant ("going
private") or during liquidation of the Registrant.
Any change in the preference, benefits, conditions of redemption and
amortization of the Preferred Shares, or the creation of a class of shares
having priority or preference over the Preferred Shares, would require the
approval of holders of a majority of the outstanding Preferred Shares at a
special meeting of holders of Preferred
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Shares. Such a meeting would be called by publication of a notice in the
Gazeta Mercantil and the Diario Oficial da Uniao at least thirty days prior to
the meeting but would not generally require any other form of notice.
In any circumstances in which holders of Preferred Shares are entitled to
vote, each Preferred Share will entitle the holder thereof to one vote.
PREEMPTIVE RIGHTS
Each shareholder of the Registrant has a general preemptive right to
subscribe for shares in any capital increase, in proportion to its
shareholding. A period of 30 days following the publication of notice of the
capital increase is allowed for exercise of the right, and the right is
negotiable. However, a shareholders' meeting is authorized to eliminate
preemptive rights with respect to the issuance of new shares, debentures,
warrants and founders' shares convertible into new shares up to the limit of
the authorized share capital, provided that the distribution of these
securities is effected (i) on a stock exchange or in a public offering, (ii)
through an exchange of shares in a public offering the purpose of which is to
acquire control of another company or (iii) through the use of certain tax
incentives.
In the event of a capital increase which would maintain or increase the
proportion of capital represented by Preferred Shares, holders of ADSs, or of
Preferred Shares, would have preemptive rights to subscribe only to newly
issued Preferred Shares. In the event of a capital increase which would reduce
the proportion of capital represented by Preferred Shares, holders of ADSs, or
of Preferred Shares, would have preemptive rights to subscribe to Preferred
Shares, in proportion to their shareholdings and to Common Shares only to the
extent necessary to prevent dilution of their interest in the Registrant.
Preemptive rights to purchase shares may not be offered to U.S. holders of
ADSs unless a registration statement under the Securities Act is effective
with respect to the shares underlying such rights, or an exemption from the
registration requirements of the Securities Act is available. Consequently,
holders of ADSs who are U.S. persons or are located in the United States may
be restricted in their ability to participate in the exercise of preemptive
rights. See "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
RIGHT OF REDEMPTION
Neither the Common Shares nor the Preferred Shares are redeemable, subject
to the right of a dissenting shareholder to seek redemption upon a decision
made at a shareholders' meeting by shareholders representing over 50% of the
voting shares to seek redemption upon a decision made at a shareholders'
meeting (i) to change the preference of the Preferred Shares or to create a
class of shares having priority or preference over the Preferred Shares, (ii)
to modify the mandatory distribution of dividends, (iii) to change the
corporate purposes of the Registrant, (iv) to dissolve or liquidate the
Registrant, (v) to transfer all of the shares of the Registrant to another
company in order to make the Registrant a wholly-owned subsidiary of such
company (incorporacao de acoes), (vi) to approve the acquisition of another
company, the price of which exceeds certain limits set forth in the Brazilian
Corporation Law, and (vii) to merge or consolidate the Registrant with another
company, if certain liquidity standards provided in the Brazilian Corporation
Law are not met. The right to redemption lapses 30 days after publication of
the minutes of the relevant shareholders' meeting or, whenever the resolution
requires the approval of the holders of Preferred Shares by vote taken in a
special meeting of a majority of the holders of Preferred Shares affected by
the resolution, within 30 days from the publication of the minutes of such
special meeting. The Registrant would be entitled to reconsider any action
giving rise to redemption rights within 10 days following the expiration of
such rights if the redemption of shares of dissenting shareholders would
jeopardize the financial stability of the Registrant.
Unless otherwise provided in the By-laws (which is not the case with the
Registrant), shares are redeemable at their book value, determined on the
basis of the last annual balance sheet approved by the shareholders. If the
shareholders' meeting giving rise to redemption rights occurs more than 60
days after the date of the last annual balance sheet, a shareholder may demand
that its shares be valued on the basis of a new balance sheet that is as of a
date within 60 days of such shareholders' meeting.
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FORM AND TRANSFER
Shares of the Registrant are maintained in book-entry form with a transfer
agent (the "Transfer Agent") and the transfer of such shares is made in
accordance with the applicable provisions of the Brazilian Corporation Law,
which provides that a transfer of shares is effected by an entry made by the
Transfer Agent on its books, debiting the share account of the seller and
crediting the share account of the purchaser, against presentation of a
written order of the seller, or judicial authorization or order, in an
appropriate document which remains in the possession of the Transfer Agent.
The Preferred Shares underlying the ADS will be registered on the Transfer
Agent's records in the name of the Depositary.
Transfers of shares by a foreign investor are made in the same way and
executed by such investor's local agent on the investor's behalf except that,
if the original investment was registered with the Central Bank of Brazil
pursuant to the Annex IV Regulations, the foreign investor should also seek
amendment, if necessary, through its local agent, of the certificate of
registration to reflect the new ownership.
Each of the Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange
operates a central clearing system. A holder of shares of the Registrant may
choose, at its discretion, to participate in these systems and all shares
elected to be put into the system will be deposited in custody with the
relevant stock exchange (through a Brazilian institution duly authorized to
operate by the Central Bank of Brazil having a clearing account with the
relevant stock exchange) and the fact that such shares are subject to custody
with the relevant stock exchange will be reflected in the Registrant's
register of shareholders. Each participating shareholder will, in turn, be
registered in the register of beneficial shareholders of the Registrant
maintained by the relevant stock exchange and will be treated in the same way
as registered shareholders.
DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS IN RESPECT OF PREFERRED SHARES
The following is a summary of the material provisions of the deposit
agreement (the "Deposit Agreement"), dated as of July 27, 1998 among the
Registrant, the Depositary, and the registered holders (the "Owners") and
beneficial owners from time to time of ADSs (the "Beneficial Owners"),
pursuant to which the ADSs representing Preferred Shares are to be issued.
This summary is subject to and qualified in its entirety by reference to the
Deposit Agreement, including the form of ADRs. Terms used in this description
and not otherwise defined shall have the meanings set forth in the Deposit
Agreement. A copy of the Deposit Agreement has been filed as an exhibit to
this Registration Statement. Copies of the Deposit Agreement are available for
inspection at the Corporate Trust Office of the Depositary, currently located
at 101 Barclay Street, New York, NY 10286, and at the office of the agent of
the Custodian, currently located at the principal Sao Paulo, Brazil office of
Banco Itau. The Depositary's principal executive office is located at 1 Wall
Street, New York, NY 10015.
AMERICAN DEPOSITARY RECEIPTS
ADRs evidencing ADSs are issuable by the Depositary pursuant to the Deposit
Agreement. Each ADR is in registered form and evidences a specified number of
ADSs, each ADS representing 1,000 Preferred Shares, or evidence of the right
to receive 1,000 Preferred Shares deposited with the Custodian and registered
in the name of the Depositary or its nominee (together with any additional
Preferred Shares at any time deposited or deemed deposited under the Deposit
Agreement and any and all other securities, cash and other property received
by the Depositary or the Custodian in respect of such Preferred Shares and at
such time held under the Deposit Agreement, the "Deposited Securities"). Only
persons in whose names ADRs are registered on the books of the Depositary are
treated by the Depositary and the Registrant as Owners.
DEPOSIT, TRANSFER AND WITHDRAWAL
The By-laws provide that ownership of capital generally must be evidenced
only by a record of ownership maintained by the Registrant or an accredited
intermediary, such as a bank, acting as a registrar for the shares. Currently,
such function is performed by the Registrant as registrar (the "Registrar").
Accordingly, all references to the deposit, surrender and delivery of the
Preferred Shares refer only to book-entry transfers of the Preferred
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Shares in Brazil. See "--Capital Stock" for a description of the
characteristics and rights of the Preferred Shares. All references to the
deposit, surrender and delivery of the ADS or the ADRs refer not only to the
physical transfer of any certificates representing such ADRs but also to any
book-entry transfers.
The Preferred Shares represented by ADSs were deposited pursuant to the
Deposit Agreement by book-entry transfer to an account of the Custodian and
registered in the name of the Custodian. The Depositary is the holder of
record on the books of the Custodian of all such Preferred Shares.
The Depositary has agreed, subject to the terms and conditions of the
Deposit Agreement, that upon delivery (including by book-entry credit) to the
Custodian of the Preferred Shares (or evidence of rights to receive Preferred
Shares) and pursuant to appropriate instruments of transfer in a form
satisfactory to the Custodian, the Depositary will, upon payment of the fees,
charges and taxes provided in the Deposit Agreement, execute and deliver at
its Corporate Trust Office to, or upon the written order of, the person or
persons named in the notice of the Custodian delivered to the Depositary or
requested by the person depositing such Preferred Shares with the Depositary,
an ADR or ADRs, registered in the name or names of such person or persons, and
evidencing any authorized number of ADSs requested by such person or persons.
The Depositary will refuse to accept Preferred Shares for deposit whenever
it is notified in writing that such deposit would result in any violation of
applicable laws. Neither the Depositary nor the Custodian, nor any nominee or
person on their behalf, will accept any Restricted ADR evidencing Restricted
ADSs issued pursuant to the Restricted Deposit Agreement, or Preferred Shares
withdrawn pursuant to the Restricted Deposit Agreement for the purpose of
deposit under the Deposit Agreement, or issue ADSs or ADRs against delivery
thereof, as long as such Restricted ADSs, Restricted ADRs or Preferred Shares
are or may be deemed restricted securities within the meaning of Rule
144(a)(3) under the Securities Act.
Upon surrender at the Corporate Trust Office of the Depositary of an ADR for
the purpose of withdrawal of the Deposited Securities represented by the ADSs
evidenced by such ADR, and upon payment of the fees of the Depositary,
governmental charges and taxes provided in the Deposit Agreement, and subject
to the terms and conditions of the Deposit Agreement, the By-laws, the
Deposited Securities and applicable law, the Owner of such ADR will be
entitled to book-entry credit with the Registrar together with physical
delivery (if physical delivery is permitted under the By-laws), to him or upon
his order, as permitted by applicable law, of the amount of Deposited
Securities at the time represented by the ADS or ADSs evidenced by such ADR.
Any forwarding of share certificates (if any), other securities, property,
cash and other documents of title for such delivery will be at the risk and
expense of the Owner.
Subject to the terms and conditions of the Deposit Agreement and any
limitations that may be established by the Depositary and unless requested by
the Registrant to cease doing so, the Depositary may execute and deliver ADRs
prior to the receipt of Preferred Shares (a "Pre-Release"), may deliver
Preferred Shares upon the receipt, and cancellation of ADRs which have been
Pre-Released, whether or not such cancellation is prior to the termination of
such Pre-Release or the Depositary knows that such ADR has been Pre-Released,
and may receive ADRs in lieu of Preferred Shares in satisfaction of a Pre-
Release.
Each Pre-Release must be (a) preceded or accompanied by a written
representation and agreement from the person to whom the ADRs are to be
delivered (the "Pre-Releasee") that the Pre-Release or its customer (i) owns
the Preferred Shares or ADRs to be remitted, as the case may be, (ii) assigns
all beneficial right, title and interest in such Preferred Shares or ADRs, as
the case may be, to the Depositary for the benefit of the Owners and (iii)
agrees in effect to hold such Preferred Shares or ADRs, as the case may be,
for the account of the Depositary until delivery of the same upon the
Depositary's request, (b) at all times fully collateralized with cash or U.S.
government securities, (c) terminable by the Depositary on not more than five
business days' notice and (d) subject to such further indemnities and credit
regulations as the Depositary deems appropriate. The Depositary will set
limits with respect to Pre-Release transactions to be entered into hereunder
with any particular Pre-Releasee on a case by case basis as the Depositary
deems appropriate. The collateral referred to in clause (b) above shall be
held by the Depositary for the benefit of the Owners as security for the
performance of the
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Pre-Releasee's obligations to the Depositary in connection with a Pre-Release
transaction, including the Pre-Releasee's obligation to deliver Preferred
Shares or ADRs upon termination of a Pre-Release transaction.
The Depositary will also limit the number of ADRs involved in such Pre-
Release transactions so that Preferred Shares not deposited but represented by
ADSs outstanding at any time as a result of Pre-Releases will not normally
exceed thirty percent (30%) of the ADSs outstanding (without giving effect to
ADSs evidenced by ADRs outstanding as a result of the Pre-Release), but the
Depositary reserves the right to disregard such limit from time to time as it
deems appropriate and may, with the prior written consent of the Registrant,
change such limit for purposes of general application. The Depositary may
retain for its own account any compensation received by it in connection with
the foregoing. Neither the Registrant nor the Custodian shall incur any
liability to Owners of ADRs as a result of such transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND RIGHTS
The Depositary is required to convert, as promptly as practicable and, in
any event, within one business day of its receipt thereof, into U.S. dollars,
all cash dividends or other distributions, net proceeds from the sale of
securities, property or rights, denominated in any currency other than U.S.
dollars that it receives in respect of the deposited Preferred Shares if
permitted under applicable laws and the Depositary determines that such
conversion into U.S. dollars and transfer to the United States can be effected
on a reasonable basis. If at the time of conversion, the resulting U.S.
dollars can, pursuant to applicable law, be transferred out of Brazil for
distribution, the Depositary will as promptly as practicable distribute the
amount received to the Owner entitled thereto in proportion to the number of
ADSs evidenced by such Owner's ADRs without regard to any distinctions among
Owners on account of exchange restrictions or otherwise. The amount
distributed will be reduced by any amounts to be withheld by the Registrant,
the Depositary or the Custodian, including amounts on account of any
applicable taxes and certain other expenses. For further details about
applicable taxes, see "Taxation."
If such conversion, transfer or distribution can be effected only with the
approval or license of any government or agency thereof, the Depositary will
file as promptly as practicable such application for approval or license;
however, the Depositary will be entitled to rely upon Brazilian local counsel
in such matters, which counsel will be instructed to act as promptly as
possible. If, pursuant to applicable law, any foreign currency received by the
Depositary or the Custodian cannot be converted to U.S. dollars, or if any
approval or license of any government or agency thereof that is required for
such conversion is denied or, in the opinion of the Depositary, cannot be
promptly obtained at a reasonable cost, the Depositary will, (a) as to the
portion of the foreign currency that is convertible into U.S. dollars, make
such conversion and (i) if permitted by applicable law, transfer such U.S.
dollars to the United States and distribute them to the Owners entitled
thereto or (ii) to the extent that such transfer is not permitted, hold such
U.S. dollars for the benefit of the Owners entitled thereto, uninvested and
without liability for interest thereon and (b) as to the nonconvertible
balance, if any, (i) if requested in writing by an Owner, distribute or cause
the Custodian to distribute the foreign currency (or an appropriate document
evidencing the right to receive such foreign currency) received by the
Depositary or the Custodian to such Owner and (ii) the Depositary shall hold
or will cause the Custodian to hold any amounts of nonconvertible foreign
currency not distributed pursuant to the immediately preceding subclause (i)
uninvested and without liability for the interest thereon for the respective
accounts of the Owners entitled to receive the same.
If the Registrant declares a dividend in, or free distribution of,
additional Preferred Shares with respect to the Preferred Shares represented
by the ADSs, the Depositary may, or will if the Registrant so requests,
distribute as promptly as practicable to the Owners of outstanding ADRs
entitled thereto, in proportion to the number of ADSs evidenced by their
respective ADRs, additional ADRs evidencing an aggregate number of ADSs that
represents the number of Preferred Shares received as such dividend or free
distribution, subject to the terms and conditions of the Deposit Agreement
with respect to the deposit of Preferred Shares and the issuance of ADSs
evidenced by ADRs, including the withholding of any tax or other governmental
charge and the payment of fees of the Depositary.
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The Depositary may withhold any such distribution of ADRs if it has not
received satisfactory assurances from the Registrant that such distribution
does not require registration under the Securities Act or is exempt from
registration under the provisions of such Act. In lieu of delivering ADRs for
fractional ADSs in the event of any such dividend or free distribution, the
Depositary will sell the amount of Preferred Shares represented by the
aggregate of such fractions and distribute the net proceeds in accordance with
the Deposit Agreement. If additional ADRs are not so distributed, each ADS
will thereafter also represent the additional Preferred Shares distributed
upon the Deposited Securities represented thereby.
If the Registrant offers, or causes to be offered, to the holders of
Preferred Shares any rights to subscribe for additional Preferred Shares or
any rights of any other nature, the Depositary, after consultation with the
Registrant, will have discretion as to the procedure to be followed in making
such rights available to Owners or in disposing of such rights for the benefit
of such Owners and making the net proceeds available to such Owners. If, by
the terms of such rights offering or for any other reason, it would be
unlawful for the Depositary to either make such rights available to any Owners
or dispose of such rights and make the net proceeds available to such Owners,
then the Depositary will allow the rights to lapse. If at the time of the
offering of any rights, the Depositary determines in its discretion that it is
lawful and feasible to make such rights available to all or certain Owners,
the Depositary may, and at the request of the Company will, distribute to any
Owners to whom it determines the distribution to be lawful and feasible, in
proportion to the number of ADSs held by such Owner, warrants or other
instruments therefor in such form as it deems appropriate.
If the Depositary determines that it is not lawful or feasible to make such
rights available to all or certain Owners, it may, and at the request of the
Registrant, will use its best efforts that are reasonable under the
circumstances to, sell the rights, warrants or other instruments in proportion
to the number of ADSs held by the Owners to whom it has determined it may not
lawfully or feasibly make such rights available, and allocate net proceeds of
such sales for the account of such Owners otherwise entitled to such rights,
warrants or other instruments, upon an averaged or other practical basis
without regard to any distinctions among such Owners because of exchange
restrictions or the date of delivery of any ADR or ADRs or otherwise. The
Depositary will not be responsible for any failure to determine that it may be
lawful or feasible to make such rights available to Owners in general or any
Owner or Owners in particular.
In circumstances in which rights would not otherwise be distributed, if an
Owner requests the distribution of warrants or other instruments in order to
exercise the rights allocable to the ADSs of such Owner, the Depositary will
promptly make such rights available to such Owner upon written notice from the
Registrant to the Depositary that (a) the Registrant has elected in its sole
discretion to permit such rights to be exercised and (b) such Owner has
executed such documents as the Registrant has determined in its sole
discretion are reasonably required under applicable law. Upon instruction
pursuant to such warrants or other instruments to the Depositary from such
Owner to exercise such rights, upon payment by such Owner to the Depositary
for the account of such Owner of an amount equal to the purchase price of the
Preferred Shares to be received in exercise of the rights, and upon payment of
the fees of the Depositary as set forth in such warrants or other instruments,
the Depositary will, on behalf of such Owner, exercise the rights and purchase
the Preferred Shares, and the Registrant will cause the Preferred Shares so
purchased to be delivered to the Depositary on behalf of such Owner. As agent
for such Owner, the Depositary will cause the Preferred Shares so purchased to
be deposited, and will execute and deliver ADRs to such Owner, pursuant to the
Deposit Agreement. Such a disposal of rights may reduce the Owners'
proportionate equity interest in the Registrant.
The Depositary will not offer rights to Owners having an address of record
in the United States unless a registration statement under the Securities Act
is in effect with respect to such rights and the Securities to which such
rights relate or unless the offering and sale thereof to such Owners are
exempt from registration under the Securities Act; however, the Registrant
will have no obligation to file a registration statement under the Securities
Act to make available to Owners any right to subscribe for or to purchase any
of the Securities.
Whenever the Depositary receives any distribution other than cash, Preferred
Shares or rights in respect of the Deposited Securities, the Depositary will,
as promptly as practicable, cause the securities or property received
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by it to be distributed to the Owners entitled thereto, after deduction or
upon payment of any fees and expenses of the Depositary or any taxes or other
governmental charges, in proportion to their holdings, respectively, in any
manner that the Depositary may deem equitable and practicable for
accomplishing such distribution; provided, however, that if in the opinion of
the Depositary such distribution cannot be made proportionately among the
Owners entitled thereto, or if for any other reason (including, but not
limited to, any requirement that the Registrant or the Depositary withhold an
amount on account of taxes or other governmental charges or that such
securities must be registered under the Securities Act, in order to be
distributed to Owners) the Depositary deems such distribution not to be
feasible, the Depositary may, after consultation with the Registrant, adopt
such method as it may deem equitable and practicable for the purpose of
effecting such distribution, including, but not limited to, the public or
private sale of the securities or property thus received, or any part thereof,
and the net proceeds of any such sale (net of the fees and expenses of the
Depositary) will be distributed by the Depositary to the Owners entitled
thereto as in the case of a distribution received in cash.
In connection with any distribution to Owners, the Registrant will remit to
the appropriate governmental authority or agency all amounts (if any) required
to be withheld by the Registrant and owing to such authority or agency by the
Registrant; and the Depositary and the Custodian will remit to the appropriate
governmental authority or agency all amounts (if any) required to be withheld
and owing to such authority or agency by the Depositary or Custodian. If the
Depositary determines that any distribution of property other than cash
(including Preferred Shares and rights to subscribe therefor) is subject to
any tax or governmental charge that the Depositary is obligated to withhold,
the Depositary may, by public or private sale, dispose of all or a portion of
such property in such amounts and in such manner as the Depositary deems
necessary and practicable to pay such taxes or governmental charges, and the
Depositary will distribute the net proceeds of any such sale or the balance of
any such property after deduction of such taxes or governmental charges to the
Owners entitled thereto in proportion to the number of ADSs held by them,
respectively.
Upon any change in nominal or par value, or split-up, consolidation or any
other reclassification of Deposited Securities, or upon any recapitalization,
reorganization, merger or consolidation or sale of assets affecting the
Registrant or to which it is a party, any Preferred Shares or other securities
that will be received by the Depositary or the Custodian in exchange for, in
conversion of, or in respect of Deposited Securities will be treated as new
Deposited Securities under the Deposit Agreement, and ADSs will thenceforth
represent, in addition to the existing Deposited Securities, the right to
receive the new Deposited Securities so received in exchange or conversion,
unless additional ADRs are delivered pursuant to the following sentence. In
any such case the Depositary may, and will if the Company so requests, execute
and deliver additional ADRs as in the case of a distribution in Preferred
Shares, or call for the surrender of outstanding ADRs to be exchanged for new
ADRs specifically describing such new Deposited Securities.
RECORD DATES
Whenever any cash dividend or other cash distribution shall become payable,
or whenever any distribution other than cash shall be made, or whenever rights
shall be issued with respect to the Deposited Securities, or whenever for any
reason the Depositary causes a change in the number of Preferred Shares that
are represented by each ADS or whenever the Depositary shall receive notice of
any meeting of holders of Preferred Shares or other Deposited Securities, or
whenever the Depositary shall find it necessary or convenient, the Depositary
will fix a record date, which date shall, to the extent practicable, be either
the same date as the record date fixed by the Registrant or, if different from
the record date fixed by the Registrant, fixed after consultation with the
Registrant, (a) for the determination of the Owners who will be (i) entitled
to receive such dividend, distribution of rights, or the net proceeds of the
sale thereof, or (ii) entitled to give instructions for the exercise of voting
rights at any such meeting, or (b) on or after which such ADS will represent
the changed number of Preferred Shares, all subject to the provisions of the
Deposit Agreement.
VOTING OF THE DEPOSITED SECURITIES
Preferred Shares do not entitle the holders thereof to vote on any matter
presented to a vote of shareholders of the Registrant except as set forth
under "--Capital Stock--Voting Rights." With respect to the circumstances
70
<PAGE>
set forth thereunder and if, in the future, the terms of the Preferred Shares
should be revised or amended so as to provide for voting rights, or should the
Preferred Shares obtain voting rights pursuant to the Brazilian Corporation
Law or through any change in the laws, rules, or regulations applicable to
such shares or through any change in interpretation of such laws, the
following shall apply.
As soon as practicable after receipt of notice of any meeting or
solicitation of consents or proxies of holders of Preferred Shares or other
Deposited Securities, if requested in writing by the Registrant, the
Depositary will, as soon as practicable thereafter, mail to all Owners a
notice, the form of which notice will be in the sole discretion of the
Depositary, containing (a) the information included in such notice of meeting
received by the Depositary from the Registrant (or a summary in English of the
notice of such meeting), (b) a statement that the Owners as of the close of
business on a specified record date will be entitled, subject to any
applicable provision of Brazilian law, the By-laws and the provisions of the
Deposited Securities, to instruct the Depositary as to the exercise of the
voting rights, if any, pertaining to the Preferred Shares or other Deposited
Securities represented by their respective ADSs and (c) a statement as to the
manner in which such instructions may be given, including an express
indication that instructions may be given or deemed given in accordance with
the last sentence of this paragraph if no instruction is received, to the
Depositary to give a discretionary proxy to a person designated by the
Registrant. Upon the written request of an Owner on such record date, received
on or before the date established by the Depositary for such purpose, the
Depositary will endeavor, insofar as practicable, to vote or cause to be voted
the amount of Preferred Shares or other Deposited Securities represented by
the ADSs evidenced by such ADRs in accordance with the instructions set forth
in such request. The Depositary may not itself exercise any voting discretion
over any Preferred Shares. If the Depositary does not receive instructions
from an Owner on or before the date established by the Depositary for such
purpose, the Depositary will deem such Owner to have instructed the Depositary
to give a discretionary proxy to a person designated by the Registrant to vote
the underlying Preferred Shares, provided that no such discretionary proxy
will be given with respect to any matter as to which the Registrant informs
the Depositary that (i) the Registrant does not wish such proxy given, (ii)
substantial opposition exists or (iii) the rights of holders of Preferred
Shares will be materially and adversely affected. Under Brazilian law the
Depositary may vote the Preferred Shares or other Deposited Securities
represented by ADSs and evidenced by ADRs in accordance with the instructions
of the Owners even if those instructions differ among such Owners.
Owners are not entitled to attend meetings of shareholders. An Owner of ADRs
wishing to do so must cancel its ADRs and obtain delivery of the underlying
shares, registered in the name of such Owner, prior to the record date for
attendance at such meeting.
REPORTS AND OTHER COMMUNICATIONS
The Depositary will make available for inspection by Owners at its Corporate
Trust Office any reports and communications, including any proxy soliciting
material, received from the Registrant, which are both (a) received by the
Depositary as the holder of the Deposited Securities and (b) made generally
available to holders of such Deposited Securities by the Registrant. The
Depositary will also send to Owners copies of such reports when furnished by
the Registrant pursuant to the Deposit Agreement. Any such reports and
communications furnished to the Depositary by the Registrant will be furnished
in English, to the extent that such materials are required to be translated
into English pursuant to any regulations of the Commission.
AMENDMENT AND TERMINATION OF THE DEPOSIT AGREEMENT
The form of the ADRs and any provision of the Deposit Agreement may at any
time and from time to time be amended by agreement between the Registrant and
the Depositary in any respect which they may deem necessary or desirable. Any
amendment that imposes or increases any fees or charges (other than taxes and
other governmental charges, registration fees, cable, telex or facsimile
transmission costs, delivery costs or other such expenses), or which otherwise
prejudices any substantial existing rights of Owners, will not take effect as
to the outstanding ADRs until the expiration of 30 days after notice of such
amendment has been given to the Owners of outstanding ADRs. Every Owner and
Beneficial Owner at the time such amendment becomes effective will be deemed,
by continuing to hold such ADR, to consent and agree to such amendment and to
be bound by the
71
<PAGE>
Deposit Agreement as amended thereby. In no event will any amendment impair
the right of any Owner to surrender his ADR and receive therefor the Preferred
Shares and other property represented thereby, except to comply with mandatory
provisions of applicable law.
The Depositary will at any time at the direction of the Registrant terminate
the Deposit Agreement by mailing notice of such termination to the Owners then
outstanding at least 30 days prior to the date fixed in such notice for such
termination. The Depositary may likewise terminate the Deposit Agreement by
mailing notice of such termination to the Registrant and the Owners, if at any
time after 60 days have expired after the Depositary shall have delivered
written notice of its election to resign to the Registrant, a successor
depositary shall not have been appointed and accepted its appointment, in
accordance with the terms of the Deposit Agreement. If any ADRs remain
outstanding after the date of termination, the Depositary thereafter will
discontinue the registration of transfer of ADRs, will suspend the
distribution of dividends to the holders thereof and will not give any further
notices or perform any further acts under the Deposit Agreement, except for
(1) the collection of dividends and other distributions pertaining to the
Deposited Securities, (2) the sale of rights and other property and (3) the
delivery of Preferred Shares, together with any dividends or other
distributions received with respect thereto and the net proceeds of the sale
of any rights or other property, in exchange for surrendered ADRs (after
deducting, in each case, the fees of the Depositary for the surrender of an
ADR and other expenses set forth in the Deposit Agreement and any applicable
taxes or governmental charges).
At any time after the expiration of one year from the date of termination,
the Depositary may sell the Deposited Securities then held thereunder and hold
uninvested the net proceeds of such sale, together with any other cash,
unsegregated and without liability for interest, for the pro rata benefit of
the Owners that have not theretofore surrendered their ADRs, such Owners
thereupon becoming general creditors of the Depositary with respect to such
net proceeds. After making such sale, the Depositary will be discharged from
all obligations under the Deposit Agreement, except to account for net
proceeds and other cash (after deducting, in each case, the fee of the
Depositary and other expenses set forth in the Deposit Agreement for the
surrender of an ADR and any applicable taxes or other governmental charges)
and certain indemnification obligations. Upon termination of the Deposit
Agreement, the Registrant will also be discharged from all obligations
thereunder, except for certain obligations to the Depositary.
CHARGES OF DEPOSITARY
The Depositary will charge (to the extent permitted by applicable law) any
party depositing or withdrawing Preferred Shares or any party surrendering
ADRs or to whom ADRs are issued (including, without limitation, issuance
pursuant to a stock dividend or stock split declared by the Company or an
exchange of stock regarding the ADRs or Deposited Securities or a distribution
of ADRs pursuant to the Deposit Agreement), whichever is applicable: (1) taxes
and other governmental charges, (2) such registration fees as may from time to
time be in effect for the registration of transfers of Preferred Shares
generally on the register of the Registrant or the Registrar and applicable to
transfers of Preferred Shares to the name of the Depositary or its nominee or
the Custodian or its nominee on the making of deposits or withdrawals under
the Deposit Agreement, (3) such cable, telex and facsimile transmission
expenses as are expressly provided in the Deposit Agreement to be at the
expense of persons depositing Preferred Shares or Owners, (4) such expenses as
are incurred by the Depositary in the conversion of foreign currency pursuant
to the Deposit Agreement, (5) a fee not in excess of $5.00 per 100 ADSs (or
portion thereof) for the execution and delivery of ADRs pursuant to the
Deposit Agreement and the surrender of ADRs pursuant to the Deposit Agreement,
(6) a fee for the distribution of proceeds of sales of securities or rights
pursuant to the Deposit Agreement, such fee (which may be deducted from such
proceeds) being in an amount equal to the lesser of (i) the fee for issuance
of ADSs referred to above which would have been charged as a result of the
deposit of such securities (for purposes of this clause treating all such
securities as if they were Preferred Shares) or Preferred Shares received in
exercise of rights distributed to them pursuant to the Deposit Agreement but
which securities or rights are instead sold by the Depositary and the net
proceeds distributed and (ii) the amount of such proceeds.
The Depositary, pursuant to the Deposit Agreement, may own and deal in any
class of securities of the Company and its affiliates and in ADRs.
72
<PAGE>
LIABILITY OF OWNERS OR BENEFICIAL OWNERS FOR TAXES OR OTHER CHARGES
If any tax or other governmental charge shall become payable by the
Custodian, the Depositary or its nominee with respect to any ADR or any
Deposited Securities represented by the ADSs evidenced by such ADR, such tax
or other governmental charge will be payable by the Owner or Beneficial Owner
of such ADR. The Depositary may refuse to effect registration of transfer of
such ADR or any split-up or combination thereof or any withdrawal of Deposited
Securities underlying such ADR until such payment is made, and may withhold
any dividends or other distributions or may sell for the account of such Owner
or Beneficial Owner any part or all of the Deposited Securities underlying
such ADR and may apply such dividends or distributions or the proceeds of any
such sale in payment of any such tax or other governmental charge (and any
taxes or expenses arising out of such sale) and the Owner or Beneficial Owner
of such ADR will remain liable for any deficiency.
LIMITATION ON EXECUTION, DELIVERY, TRANSFER AND SURRENDER OF ADRS
The ADRs are transferable on the books of the Depositary, provided that the
Depositary may close the transfer books after consultation with the Registrant
to the extent practicable at any time or from time to time when deemed
expedient by it in connection with the performance of its duties or at the
request of the Registrant.
As a condition precedent to the execution and delivery, registration of
transfer, split-up, combination or surrender of any ADR, the delivery of any
distribution thereon or the withdrawal of Deposited Securities, the
Depositary, the Registrant, the Custodian or the Registrar may require payment
from the depositor of Preferred Shares or the presenter of the ADR of a sum
sufficient to reimburse it for any tax or other governmental charge and any
stock transfer or registration fee with respect thereto (including any such
tax, charge or fee with respect to Preferred Shares being deposited or
withdrawn) and payment of any other applicable fees provided for in the
Deposit Agreement. The Depositary may refuse to deliver ADRs, register the
transfer of any ADR or make any distribution of, or related to, the Preferred
Shares until it has received such proof of citizenship, residence, exchange
control approval, compliance with all applicable laws or regulations, or other
information as it may reasonably deem necessary or proper. The delivery,
transfer, registration of transfer, split-up, combination and surrender of
ADRs generally may be suspended or refused during any period when the transfer
books of the Depositary, the Registrant or the Registrar are closed or if any
such action is deemed necessary or advisable by the Depositary or the
Registrant, at any time or from time to time.
The Depositary will keep books, at its Corporate Trust Office, for the
registration and transfer of ADRs, which at all reasonable times will be open
for inspection by the Owners, provided that such inspection will not be for
the purpose of communicating with Owners in the interest of a business or
object other than the business of the Registrant or a matter related to the
Deposit Agreement or the ADRs.
The Depositary may upon notice to the Registrant appoint one or more co-
transfer agents reasonably acceptable to the Registrant for the purpose of
effecting transfers, combinations and split-ups of ADRs at designated transfer
offices on behalf of the Depositary. In carrying out its functions, a co-
transfer agent may require evidence of authority and compliance with
applicable laws and other requirements by Owners or persons entitled to ADRs
and will be entitled to protection and indemnity to the same extent as the
Depositary.
LIMITATION OF LIABILITY
Neither the Depositary nor the Registrant nor any of their respective
directors, employees, agents or affiliates will be liable to any Owners or
Beneficial Owners of ADRs if by reason of any provision of any present or
future law or regulation of the United States, Brazil or any other country, or
of any other governmental or regulatory authority or stock exchange, or by
reason of any provision, present or future, of the By-laws, or by reason of
any act of God or war or other circumstance beyond its control, the Depositary
or the Registrant or any of their respective directors, employees, agents, or
affiliates shall be prevented, delayed or forbidden from, or be subject to any
civil or criminal penalty on account of, doing or performing any act or thing
which by terms of the Deposit Agreement it is provided will be done or
performed; nor will the Depositary or the Registrant incur any liability to
any Owner or Beneficial Owner of any ADR by reason of any nonperformance or
delay,
73
<PAGE>
caused as aforesaid, in the performance of any act or thing which by the terms
of the Deposit Agreement it is provided will or may be done or performed, or
by reason of any exercise of, or failure to exercise, any discretion provided
for under the Deposit Agreement. Where, by the terms of a distribution
pursuant to the Deposit Agreement, or an offering or distribution pursuant to
the Deposit Agreement, or for any other reason, the Depositary is prevented or
prohibited from making such distribution or offering available to Owners, and
the Depositary is prevented or prohibited from making such distribution or
offering on behalf of such Owners and making the net proceeds available to
such Owners, then the Depositary, after consultation with the Registrant, will
not make such distribution or offering, and will allow the rights, if
applicable, to lapse.
The Registrant and the Depositary assume no obligation nor will they be
subject to any liability under the Deposit Agreement to Owners or Beneficial
Owners of ADRs, except that they agree to perform their respective obligations
specifically set forth under the Deposit Agreement without negligence or bad
faith.
GOVERNING LAW
The Deposit Agreement is governed by the laws of the State of New York.
74
<PAGE>
PART III
ITEM 15: DEFAULTS UPON SENIOR SECURITIES
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, the privatization of the New
Holding Companies on July 29, 1998 and the announced liquidation of Telebras
constitute events of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such
indebtedness to declare the indebtedness to be in default and to accelerate
the maturity thereof if a significant portion of the principal amount of the
Company's debt is in default or accelerated. The total amount of the Company's
outstanding debt as of December 31, 1997 which is currently or is expected to
be in default is approximately R$483.5 million. The Company is currently in
negotiations with the appropriate creditors with respect to this indebtedness.
Although none of the Company's creditors have notified the Company that they
intend to pursue their rights and remedies with respect to these defaults,
there can be no assurance that the Company will be able to obtain waivers or
that the creditors will not exercise their rights and remedies under the
credit agreements.
ITEM 16: CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES
Not applicable.
PART IV
ITEM 17: CONSOLIDATED FINANCIAL STATEMENTS
The Registrant has responded to Item 18 in lieu of responding to this Item.
ITEM 18: CONSOLIDATED FINANCIAL STATEMENTS
Reference is made to pages F-1 through F-44.
ITEM 19: CONSOLIDATED FINANCIAL STATEMENTS AND EXHIBITS
(a) The following Financial Statements are filed as part of this Form 20-F:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1996 and 1997
Consolidated Statements of Income for the Years Ended December 31, 1995,
1996 and 1997
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1995, 1996 and 1997
Notes to the Consolidated Financial Statements
(b) Exhibits
1.1* Charter of the Registrant
1.2* Charter of the Registrant (English translation)
2.1* Deposit Agreement dated as of July 27, 1998 among the Registrant,
The Bank of New York, as Depositary, and Owners and Beneficial
Owners of American Depositary Receipts issued thereunder
10.1* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements
10.2* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service (English translation)
10.3* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service and Schedule of Omitted
Concession Agreements
10.4* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service (English translation)
23.1** Consent of KPMG Peat Marwick
- --------
*Previously filed
**Filed herewith
75
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this amendment to its registration
statement on Form 20-F, Commission File No. 001-14475, to be signed on its
behalf by the undersigned, thereunto duly authorized.
Telesp Participacoes S.A.
/s/ Fernando Xavier Ferreira
By: _________________________________
Name: Fernando Xavier Ferreira
Title:President
/s/ Manuel Ramon Garcia Garcia
By: _________________________________
Name: Manuel Ramon Garcia Garcia
Title:Vice-President
Dated: November 2, 1998
76
<PAGE>
TELESP PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report.................................. F-2
Consolidated Balance Sheets................................... F-3
Consolidated Statements of Income............................. F-4
Consolidated Statements of Cash Flows......................... F-5
Consolidated Statements of Changes in Shareholders' Equity.... F-6
Notes to the Consolidated Financial Statements................ F-7 through F-44
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Telesp Participacoes S.A.
Brasilia--DF
We have audited the accompanying consolidated balance sheets of Telesp
Participacoes S.A. as of December 31, 1996 and 1997, and the related
consolidated statements of income, cash flows and changes in shareholders'
equity for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Brazil, which do not differ in any material respects from
generally accepted auditing standards in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Telesp
Participacoes S.A. as of December 31, 1996 and 1997, and the results of its
operations and cash flows for each of the years in the three-year period ended
December 31, 1997, in conformity with accounting principles generally accepted
in Brazil, including continued recognition of the effects of changes in the
purchasing power of the Brazilian currency as discussed in Note 2.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States
of America would have affected results of operations for each of the years in
the two-year period ended December 31, 1997 and shareholders' equity as of
December 31, 1996 and 1997 to the extent summarized in Note 32 of the
consolidated financial statements.
July 17, 1998
Brasilia, Brazil
KPMG Peat Marwick
F-2
<PAGE>
TELESP PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 29)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF
DECEMBER 31, 1997 AND THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------
1996 1997 1997
NOTE R$ R$ US$
----- ---------- ---------- --------------
(UNAUDITED SEE
NOTE 2B)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents:
Deposits with Banco do Brasil
S.A............................... 27 716,111 801,748 718,155
Other cash and cash equivalents.... 11 17,040 56,597 50,696
Accounts receivable:
Trade, net......................... 12 464,492 482,856 432,512
Receivable from related parties.... 25 8,127 4,540 4,067
Deferred and recoverable taxes...... 12 46,143 31,054 27,816
Other assets:
Other accounts receivable from
related parties................... 25 20,954 14,633 13,107
Other.............................. 14 162,570 175,186 156,920
---------- ---------- ----------
Total current assets............... 1,435,437 1,566,614 1,403,273
---------- ---------- ----------
Noncurrent assets:
Deferred and recoverable taxes..... 13 21,536 11,323 10,142
Other assets:
Other accounts receivable from
related parties................... 25 347,175 346,084 310,000
Other.............................. 14 14,004 40,264 36,066
---------- ---------- ----------
Total noncurrent assets............ 382,715 397,671 356,208
---------- ---------- ----------
Permanent assets:
Investments........................ 15 63,133 93,590 83,832
Property, plant and equipment,
net............................... 16 12,334,860 12,589,455 11,276,832
---------- ---------- ----------
Total permanent assets............. 12,397,993 12,683,045 11,360,664
Net assets of discontinued
operations......................... 2d 274,505 1,259,819 1,128,465
---------- ---------- ----------
Total assets....................... 14,490,650 15,907,149 14,248,610
========== ========== ==========
Current liabilities:
Payroll and related accruals....... 17 196,144 194,025 173,795
Accounts payable and accrued
expenses.......................... 18 233,359 264,785 237,178
Taxes other than income taxes...... 19 208,390 226,147 202,568
Dividends:
Payable to Telebras................ 20,27 177,223 181,186 162,296
Other.............................. 20 86,246 137,386 123,061
Income taxes........................ 9 61,056 133,956 119,989
Loans and financing:
Payable to Telebras................ 22,27 631,848 28,397 25,436
Other financing.................... 22 1,504 -- --
Provisions for contingencies........ 23 13,063 51,623 46,241
Other liabilities:
Due to related parties............. 21,27 86,002 73,472 65,812
Other liabilities.................. 21 87,566 143,110 128,188
---------- ---------- ----------
Total current liabilities.......... 1,782,401 1,434,087 1,284,564
---------- ---------- ----------
Noncurrent liabilities:
Income taxes....................... 9 408,424 565,846 506,849
Loans and financing:
Payable to Telebras................ 22,27 135,315 114,985 102,996
Other financing.................... 22 358,791 357,614 320,328
Provisions for contingencies........ 23 64,110 34,240 30,670
Other liabilities................... 21 29,706 25,491 22,832
---------- ---------- ----------
Total noncurrent liabilities....... 996,346 1,098,176 983,675
---------- ---------- ----------
Minority interests in Telesp and
CTBC............................... 2c,31 2,820,415 3,984,723 3,569,261
---------- ---------- ----------
Shareholders' equity:
Capital and reserves............... 6,987,757 7,268,928 6,511,043
Retained earnings.................. 1,180,578 1,607,744 1,440,114
---------- ---------- ----------
Total shareholders' equity......... 25 8,168,335 8,876,672 7,951,157
---------- ---------- ----------
Funds for capitalization:
Expansion plan contributions....... 26 721,222 490,740 439,574
Other funds........................ 1,931 22,751 20,379
---------- ---------- ----------
Total funds for capitalization..... 723,153 513,491 459,953
---------- ---------- ----------
Total liabilities and shareholders'
equity............................ 14,490,650 15,907,149 14,248,610
========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-3
<PAGE>
TELESP PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 29)
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------------------
1995 1996 1997 1997
NOTE R$ R$ R$ US$
---- ---------- ---------- ---------- ----------
(UNAUDITED
SEE
NOTE 2B)
<S> <C> <C> <C> <C> <C>
Net operating revenue from
telecommunications
services:
Services provided to third
parties.................. 2,553,392 3,512,597 3,734,928 3,345,511
Services provided to the
Telebras operating
companies................ 27 190,510 197,608 351,740 315,066
---------- ---------- ---------- ----------
4 2,743,902 3,710,205 4,086,668 3,660,577
Cost of services:
Provided by third
parties.................. (1,833,240) (2,073,443) (2,146,465) (1,922,666)
Provided by the Telebras
operating companies...... 27 (2,253) (128,557) (240,872) (215,758)
---------- ---------- ---------- ----------
(1,835,493) (2,202,000) (2,387,337) (2,138,424)
Gross profit.............. 5 908,409 1,508,205 1,699,331 1,522,153
Operating expenses:
Selling expense........... 6 (209,672) (250,307) (331,162) (296,634)
General and administrative
expense.................. (643,163) (585,468) (580,918) (520,349)
Other net operating
income................... 7 264,607 228,860 222,105 198,948
---------- ---------- ---------- ----------
Operating income from
continuing operations
before interest
income/expense........... 320,181 901,290 1,009,356 904,118
Allocated interest
expense.................. (27,651) (32,880) (19,353) (17,335)
---------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest income/expense.. 292,530 868,410 990,003 886,783
Net nonoperating income
(expense)................ 8 (4,001) 94,716 15,233 13,645
Employees' profit share... - (32,465) (52,940) (47,420)
---------- ---------- ---------- ----------
Income from continuing
operations before
unallocated interest
income/expense, taxes and
minority interests....... 288,529 930,661 952,296 853,008
Income from discontinued
cellular operations
before unallocated
interest income/expense,
taxes and minority
interests................ 196,410 328,741 537,377 481,348
Unallocated interest
income................... 48,585 98,405 202,751 181,611
Unallocated interest
expense.................. (66,234) (51,500) (3,332) (2,985)
---------- ---------- ---------- ----------
Income before taxes and
minority interests....... 467,290 1,306,307 1,689,092 1,512,982
Income and social
contribution taxes....... 9 (122,354) (330,591) (528,672) (473,551)
---------- ---------- ---------- ----------
Income before minority
interests................ 344,936 975,716 1,160,420 1,039,431
Minority interests in
CTBC..................... 2 (97) (25,797) (30,084) (26,947)
---------- ---------- ---------- ----------
Income attributable to
shareholders of Telesp... 344,839 949,919 1,130,336 1,012,484
Minority interests in
Telesp................... 2 (83,229) (224,058) (330,212) (295,783)
---------- ---------- ---------- ----------
Net income................ 261,610 725,861 800,124 716,701
========== ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-4
<PAGE>
TELESP PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 29)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------------------
1995 1996 1997 1997
R$ R$ R$ US$
---------- ---------- ---------- ----------
(UNAUDITED
SEE NOTE
2B)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.................... 261,610 725,861 800,124 716,701
Less: Income from discontinued
cellular operations before
unallocated interest
income/expense, taxes and
minority interests........... (196,410) (328,741) (537,377) (481,348)
---------- ---------- ---------- ----------
Income from continuing
operations, net of
unallocated interest
income/expense and taxes
applicable to both continuing
and discontinued operations.. 65,200 397,120 262,747 235,353
Adjustments to reconcile net
income to cash provided by
operating activities:
Depreciation and
amortization................ 1,180,412 1,316,306 1,459,858 1,307,648
Minority interests........... 83,326 249,855 360,296 322,730
Loss (gain) on permanent
asset disposals............. 4,709 (82,628) (9,958) (8,920)
Loss from changes in equity
holding of subsidiary....... 14,049 1,252 721 646
Other provisions............. 20,323 9,189 14,107 12,636
Allowance for doubtful
accounts.................... 1,061 9,006 8,957 8,023
Others....................... 10,059 (11,351) (8,760) (7,847)
(Increase) decrease in income
tax rate.................... 95,283 (7,872) - -
(Increase) in trade accounts
receivable.................. (19,758) (69,142) (23,734) (21,259)
(Increase) in other current
assets...................... (45,583) (29,740) (6,295) (5,639)
(Increase) decrease in other
noncurrent assets........... 329 (358,320) (13,902) (12,453)
Increase (decrease) in
payroll and related
accruals.................... (7,313) 36,416 (2,119) (1,898)
Increase (decrease) in
accounts payable and accrued
expenses.................... (92,382) 34,750 31,426 28,149
Increase in taxes other than
income taxes................ 11,906 50,796 17,757 15,906
Increase in other current
liabilities................. 77,045 13,177 38,915 34,858
Increase (decrease) in
accrued interest............ (3,989) 11,257 (7,115) (6,373)
Increase (decrease) in income
taxes....................... (186,298) (158,205) 23,926 21,431
Increase (decrease) in
provisions for
contingencies............... 79,425 (62,788) 8,690 7,784
Decrease in other noncurrent
liabilities................. (3,492) (6,459) (4,215) (3,776)
---------- ---------- ---------- ----------
1,284,312 1,342,619 2,151,302 1,926,999
---------- ---------- ---------- ----------
INVESTING ACTIVITIES:
Additions to property, plant,
and equipment................ (1,248,643) (1,323,330) (1,479,615) (1,325,345)
Capitalized interest.......... (156,631) (10,618) (8,252) (7,392)
Proceeds from asset
disposals.................... 76,919 15,556 5,210 4,667
---------- ---------- ---------- ----------
(1,328,355) (1,318,392) (1,482,657) (1,328,070)
---------- ---------- ---------- ----------
FINANCING ACTIVITIES:
Loans repaid.................. (466,483) (369,568) (619,393) (554,813)
New loans obtained............ 317,821 245,736 46 41
Expansion plan contributions
received..................... 226,940 698,896 818,992 733,601
Dividends paid................ (135,535) (220,544) (258,148) (231,233)
---------- ---------- ---------- ----------
(57,257) 354,520 (58,503) (52,404)
---------- ---------- ---------- ----------
Increase (decrease) in cash and
cash equivalents from
continuing operations......... (101,300) 378,747 610,142 546,525
Net cash provided by (used in)
discontinued operations before
unallocated interest
income/expense and taxes...... 183,471 217,893 (484,948) (434,385)
Cash and cash equivalents at
beginning of year............. 54,340 136,511 733,151 656,711
---------- ---------- ---------- ----------
Cash and cash equivalents at
end of year................... 136,511 733,151 858,345 768,851
========== ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-5
<PAGE>
TELESP PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 31)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS -- R$ OF DECEMBER 31, 1997)
<TABLE>
<CAPTION>
CAPITAL AND RETAINED
RESERVES EARNINGS TOTAL
----------- --------- ---------
<S> <C> <C> <C>
Balances at December 31, 1994............... 6,011,650 718,798 6,730,448
Capital increase:
Expansion plan contributions............... 203,471 - 203,471
Resources from Telebras.................... 183,874 - 183,874
Donations and subsidies for investments..... 31,567 - 31,567
Capitalized interest on construction in
progress................................... 86,344 - 86,344
Change in tax rates......................... 91,863 - 91,863
Tax incentive investment credits............ 2,040 - 2,040
Consolidation adjustments:
Capitalized interest....................... - 11,762 11,762
Others..................................... - (1,530) (1,530)
Net income.................................. - 261,610 261,610
Realization of unrealized income............ (109,422) 109,422 -
Appropriations:
Transfers to reserves...................... 233,458 (233,458) -
Dividends.................................. - (231,034) (231,034)
Minority interest movements................. (97,204) 91,877 (5,327)
--------- --------- ---------
Balances at December 31, 1995............... 6,637,641 727,447 7,365,088
Capital increase:
Expansion plan contributions............... 412,278 - 412,278
Donations and subsidies for investments.... 10,886 - 10,886
Capitalized interest on construction in
progress................................... 172,469 - 172,469
Change in tax rates......................... (7,872) - (7,872)
Tax incentive investment credits............ 16,530 - 16,530
Unclaimed dividends......................... - 476 476
Consolidation adjustments:
Capitalized interest....................... - 8,600 8,600
Others..................................... - (3,898) (3,898)
Net income.................................. - 725,861 725,861
Realization of unrealized income............ (242,240) 242,240 -
Deferred tax on full indexation............. - (307,024) (307,024)
Appropriations:
Transfers to reserves...................... 43,792 (43,792) -
Dividends.................................. - (263,469) (263,469)
Minority interest movements................. (55,727) 94,137 38,410
--------- --------- ---------
Balances at December 31, 1996............... 6,987,757 1,180,578 8,168,335
Capital increase:
Expansion plan contributions............... 1,028,654 - 1,028,654
Donations and subsidies for investments..... 8,763 - 8,763
Capitalized interest on construction in
progress................................... 148,308 - 148,308
Tax incentive investment credits............ 53,016 - 53,016
Unclaimed dividends......................... - 1,223 1,223
Consolidation adjustments:
Capitalized interest....................... - 10,833 10,833
Expansion plan direct contributions........ - 32,621 32,621
Others..................................... - 33 33
Net income.................................. - 800,124 800,124
Realization of unrealized income............ (206,511) 206,511 -
Deferred tax on full indexation............. - (271,469) (271,469)
Appropriations:
Transfers to reserves...................... 72,992 (72,992) -
Dividends.................................. - (318,572) (318,572)
Minority interest movements................. (824,051) 38,854 (785,197)
--------- --------- ---------
Balances at December 31, 1997............... 7,268,928 1,607,744 8,876,672
========= ========= =========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-6
<PAGE>
TELESP PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 29)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
1. OPERATIONS AND BACKGROUND
Beginning in 1995, the federal government of Brazil (the "Federal
Government") undertook a comprehensive reform of the telecommunications
industry. In July, 1995 the Federal Congress adopted a General
Telecommunications Law providing for the privatization of Telecomunicacoes
Brasileiras S.A. ("Telebras") which, through its 28 operating subsidiaries,
was the primary supplier of public telecommunications services in Brazil.
In preparation for the privatization of the Telebras system, the operating
subsidiaries have been divided into twelve separate groups, (a) three regional
fixed line operators, (b) eight regional cellular operators and (c) one
national long-distance operator. The cellular telecommunications businesses
have firstly been separated from the operating subsidiaries and subsequently
the fixed-line businesses, the new cellular businesses and the long-distance
operator have been combined into the twelve separate groups. Both the
separation of the cellular businesses and the subsequent grouping of the
former Telebras subsidiaries have been performed using a procedure under
Brazilian corporate law called cisao or "spin-off". As part of this process
Telesp Participacoes S.A. (the "Holding Company") was formed.
Telesp Participacoes S.A. was formed on May 22, 1998, through the spin-off
of certain assets and liabilities of Telebras, including the 71.4% of the
share capital of Telecomunicacoes de Sao Paulo S.A. ("Telesp") and the 29.6%
of the share capital of Telesp's subsidiary Company Telefonica da Borda do
Campo ("CTBC"), owned by Telebras. The Holding Company and its subsidiaries,
Telesp and CTBC (the "Company") are the principal providers of fixed-line
telecommunications services in the state of Sao Paulo under the terms of the
concessions to be granted by the Federal Government which will expire on
December 31, 2005 and may be renewed for a further term of 20 years. Until
August 4, 1998, the Company was controlled by the Federal Government (see Note
31d).
On January 30, 1998 the cellular telecommunications business of Telesp was
spun off into a new company, Telesp Celular S.A., effective January 1, 1998.
The Company's business, including the services it may provide and the rates
it charges, is regulated by the Agencia Nacional de Telecomunicacoes
("Anatel"), the regulatory authority for the Brazilian telecommunications
industry pursuant to Law No. 9,472 of July 16, 1997 and the related
regulations, decrees, orders and plans.
2. PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements present the consolidated financial
condition and results of operations of the Holding Company and its
subsidiaries Telesp and CTBC. The portion of equity and net income
attributable to shareholders other than Telebras at December 31, 1996 and
1997, and for each of the years in the three year period ended December 31,
1997 is reflected as "minority interests." At December 31, 1997, such minority
shareholders owned 28.6% and 30.2% of the share capital of Telesp and CTBC,
respectively.
The fixed line telecommunications business of the Company is presented as
continuing operations and the cellular telecommunications business is
presented as discontinued operations for all periods. The assets and
liabilities of the cellular telecommunications business are presented as net
assets of discontinued operations. The formation of the Holding Company and
the transfer of assets and liabilities from the Company to Telesp Celular S.A.
have been accounted for as a reorganization of entities under common control
in a manner similar to a pooling of interests.
F-7
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
The assets and liabilities of the cellular telecommunications business were
transferred from Telesp to Telesp Celular S.A. at their indexed historical
cost. The associated revenues and expenses were also allocated to Telesp
Celular S.A. The consolidated financial statements are not necessarily
indicative of the financial position and results of operations that would have
occurred for the three-year period ended December 31, 1997 had the fixed-line
telecommunications business of the Holding Company and its subsidiaries Telesp
and CTBC been a separate legal entity during such period.
As separate records of revenues and costs of services were maintained for
the cellular business, the actual amounts could be identified and transferred.
With respect to costs other than cost of services, the methodologies employed
in transferring the assets and liabilities included the specific
identification of costs associated with those assets and liabilities, and the
allocation of costs where specific identification was not possible.
Allocations were made using criteria established by management that were
designed to ensure that all relevant costs were appropriately included in the
results of operations for the periods presented. The allocation criteria
included: square footage (in relation to land and building related expenses),
number of terminals (in relation to general management, accounting, data
processing, legal department and other general staff functions), number of
employees (in relation to human resource related expenses), number of
requisitions issued (in relation to office material costs) and miles driven
(in relation to certain transport costs). Management believes that the amounts
included in the financial statements fairly reflect the operating results of
the business.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from Telesp.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, interest income and expense
relating to the cellular telecommunications business could not be identified
and consequently, income from discontinued operations is presented before
unallocated interest income/expense and income tax expense.
The presentation of the consolidated financial statements is consistent with
the presentation of the published financial statements of Telesp, except for
certain reclassifications within the consolidated balance sheets and the
consolidated statements of income which have been made to conform previously
published financial statements to the 1997 presentation within this
registration statement, for the presentation of the cellular business of the
Company as discontinued operations and to reflect the portion of equity and
net income attributable to shareholders other than Telebras as minority
interests.
The accompanying consolidated financial statements were prepared on a fully
indexed basis to recognize the effects of changes in the purchasing power of
the Brazilian currency during the periods presented.
F-8
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
A. FULL INDEXATION TO DECEMBER 31, 1997
The principal criteria adopted to prepare the fully indexed consolidated
financial statements maintained in accordance with the practices described in
Note 3, are as follows:
i. Inflation restatement index
The consolidated financial statements were indexed and expressed in currency
of constant purchasing power of December 31, 1997 by using the monthly average
values of the Unidade Fiscal de Referencia (the Tax Reference Unit or "UFIR")
through December 31, 1995 and the Indice Geral de Precos-Mercado (the General
Prices Index-Market or the "IGP-M") of the Fundacao Getulio Vargas in 1996 and
1997 following the cessation of the widespread use of the UFIR which resulted
from the change in Brazil's corporate law. Inflation for the three year period
ended December 31, 1997, as measured by the UFIR and the IGP-M, was as
follows:
<TABLE>
<CAPTION>
ANNUAL
PERIOD INDEX INFLATION
------ ----- ---------
%
<S> <C> <C>
Year ended December 31, 1995................................. UFIR 22.5
Year ended December 31, 1996................................. IGP-M 9.2
Year ended December 31, 1997................................. IGP-M 7.7
</TABLE>
Management believes that these indices are appropriate indications of
general price level inflation to be used under Brazilian and US GAAP, for the
years indicated.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%. However, for accounting purposes, the constant currency method continued
to be applied through December 31, 1997. The Brazilian Institute of
Accountants has not yet published definitive rules regarding when the constant
currency method of accounting may no longer be used to prepare financial
statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare financial statements
beginning January 1, 1998, the restated balances of nonmonetary assets and
liabilities of the Company as of December 31, 1997 will become the new basis
for accounting, and income statement items will no longer be restated for
inflation.
ii. Consolidated statements of income
Items in the consolidated statements of income are adjusted to the balance
sheet date by:
. allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest income
and expense captions;
. allocating inflationary holding gains and losses from other monetary
items to their corresponding income or expense captions. Amounts without
a corresponding income or expense caption were allocated to "other net
operating income."
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial reporting
purposes herein is not permitted for tax purposes. Accordingly, a deferred tax
liability arises for the excess of net assets shown for financial reporting
purposes over the tax basis of these net assets. The charge relating to the
additional deferred tax liability of R$307,024 in 1996 and R$271,469 in 1997
was recorded directly against retained earnings.
F-9
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
B. TRANSLATION OF CONSTANT BRAZILIAN REAL AMOUNTS INTO US DOLLAR AMOUNTS
The translation of Brazilian Real amounts into US dollar amounts is
unaudited and included solely for the convenience of readers outside of Brazil
and has been performed using the closing selling exchange rate published by
the Central Bank of Brazil of R$1.1164 to US$1.00 as of December 31, 1997.
This translation should not be construed as a representation that Brazilian
Real amounts could be converted to US dollars at this or any other rate.
C. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the financial records of the
Holding Company and its subsidiaries Telesp and CTBC. All material
intercompany accounts and transactions have been eliminated.
Minority interests relate to the interest of shareholders other than Telesp
in the financial position and results of operations of CTBC and the interest
of shareholders other than Telebras in the Company.
D. DISCONTINUED OPERATIONS
The consolidated financial statements reflect the cellular
telecommunications business of Telesp as discontinued operations. Accordingly,
the revenues, costs and expenses, assets and liabilities, and cash flows of
these discontinued operations have been excluded from the respective captions
in the consolidated statements of income, balance sheets and statements of
cash flows and have been reported as "Income from discontinued cellular
operations before unallocated interest income/expense, taxes and minority
interests"; as "Net assets of discontinued operations" and as "Net cash
provided by (used in) discontinued operations" for all periods presented.
Summarized financial information for the discontinued operations is as
follows:
<TABLE>
<CAPTION>
1995 1996 1997
------- --------- ---------
<S> <C> <C> <C>
Net operating revenues......................... 524,415 773,936 1,296,265
Income before unallocated interest
income/expense, taxes and minority interests.. 196,410 328,741 537,377
Current assets......................................... 128,912 391,475
Property, plant and equipment, net..................... 1,195,581 1,892,685
Total assets........................................... 1,334,272 2,291,625
Current liabilities.................................... 252,026 311,644
Total liabilities...................................... 1,059,767 1,031,806
Net assets of discontinued operations.................. 274,505 1,259,819
</TABLE>
3. SUMMARY OF THE PRINCIPAL ACCOUNTING PRACTICES
A. CASH AND CASH EQUIVALENTS
Cash equivalents are considered to be all highly liquid temporary cash
investments with original maturity dates of three months or less.
B. TRADE ACCOUNTS RECEIVABLE
Accounts receivable from telephone subscribers are calculated at the tariff
rate on the date the services were rendered and discounted to their present
value at the balance sheet date by applying the interest rate published
F-10
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
by the National Association of Investment Bankers ("ANBID"). Trade accounts
receivable also include services provided to customers up to the balance sheet
date but not yet invoiced.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Provision is made for trade accounts receivable for which recoverability is
considered improbable.
D. FOREIGN CURRENCY TRANSACTIONS
Transactions in foreign currency are recorded at the prevailing exchange
rate at the time of the related transactions. Foreign currency denominated
assets and liabilities are translated using the exchange rate at the balance
sheet date. Exchange differences are recognized in the statement of income as
they occur.
E. INVENTORIES
Inventories are stated at the lower of indexed cost or replacement value.
Cost of inventories is determined principally on the average cost basis.
Inventories are separated into network expansion and maintenance inventories.
Inventories for use in network expansion are classified as "Construction-in-
progress" under "Property, plant and equipment". Maintenance inventories are
classified as other current assets.
F. INVESTMENTS
Other investments, which comprise items held to maturity or for investment
purposes, are recorded at indexed cost, less a provision for losses when
considered necessary.
G. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at indexed cost. Improvements to
existing property are capitalized while maintenance and repair costs are
charged to expense as incurred. Materials allocated to specific projects are
added to construction-in-progress. Depreciation is provided using the
straight-line method based on the estimated useful lives of the underlying
assets as determined by the public telecommunications service regulators. The
principal depreciation rates are shown in Note 16(b).
Interest, calculated monthly at a rate of 12% per annum on construction-in-
progress, is capitalized as part of property, plant and equipment until the
asset is placed in service.
H. ACCOUNTS PAYABLE
Accounts payable to suppliers are discounted to their present value using
the ANBID interest rate.
I. VACATION PAY ACCRUAL
Cumulative vacation pay due to employees is accrued as earned.
J. INCOME AND SOCIAL CONTRIBUTION TAXES
Income and social contribution taxes comprise federal income tax and social
contribution tax. Deferred taxes are provided on temporary differences.
K. LOANS AND FINANCING
Loans and financing include accrued interest to the balance sheet date.
L. PROVISIONS FOR CONTINGENCIES
Provisions for contingencies are based on legal advice and management's
opinion as to the likely outcome of the outstanding matters at the balance
sheet date.
F-11
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
M. REVENUE RECOGNITION
Revenues for all services are recognized when the service is provided.
Revenues from local services consist of line rental charges, service charges
based on the number of calls, network services, including interconnection and
leasing high-capacity lines, maintenance charges and charges for other
customer services. In 1997 revenue from local services also includes
installation fees which are recognized when the installation is complete.
Charges to customers for domestic, long-distance and international calls are
based on time, distance and use of services. Billings are monthly; unbilled
revenues from the billing date to the month end are estimated and recognized
as revenue during the month in which the service was provided. The revenues
from outgoing interregional and international long distance calls are divided
between the Company and Empresa Brasileira de Telecomunicacoes S.A.
("Embratel"), a subsidiary of Telebras. The Company retains a fixed percentage
of the customer charges for outgoing interregional and international long
distance calls and pays the balance to Embratel.
N. INTEREST INCOME
Interest income represents interest earned and gains and losses on
investments after adjusting for the effects of inflation as measured by the
variation in the inflation index. Unallocated interest income represents
interest income that could not be allocated between continuing and
discontinued operations.
O. INTEREST EXPENSE
Interest expense represents interest incurred and gains and losses on loans
and financing after adjusting for the effects of inflation as measured by the
variation in the inflation index and net exchange gains of R$36,398, R$14,089
and R$22,684 in 1995, 1996 and 1997, respectively. Unallocated interest
expense represents interest expense that could not be allocated between
continuing and discontinued operations.
P. RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Total
research and development costs were R$26,000, R$27,745, and R$23,610 for 1995,
1996 and 1997, respectively.
Q. PENSION AND POST-RETIREMENT BENEFITS
The Company sponsors a separate entity that provides pensions and other
post-retirement benefits for its employees through a multi-employer plan.
Current contributions and costs are determined actuarially and are recorded on
the accrual basis.
R. EMPLOYEE'S PROFIT SHARE
The Company has made a provision for granting employees the right to a share
of its profits. The amount recorded is the employee's profit share
attributable to the continuing fixed-line telecommunications business.
S. EARNINGS PER THOUSAND SHARES
Earnings per thousand shares has not been calculated as the capital
structure of Telesp Participacoes S.A. was not in place at December 31, 1997.
T. SEGMENT INFORMATION
The business operates solely in the segment of local and regional fixed-line
telecommunications. All revenues are generated in relation to services
provided in the state of Sao Paulo.
F-12
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
U. USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
Brazilian and US GAAP requires management to make estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements, and the reported amounts of revenues and expenses during the
period reported. Actual results could differ from those estimates.
4. OPERATING REVENUE FROM FIXED TELECOMMUNICATIONS SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
--------- ---------- ----------
<S> <C> <C> <C>
Local services:
Monthly charges......................... 397,397 660,037 985,928
Measured service charges................ 730,479 1,063,737 1,355,632
Public telephones....................... 107,581 133,270 174,216
Other................................... 74,111 105,243 121,500
--------- ---------- ----------
Total................................... 1,309,568 1,962,287 2,637,276
--------- ---------- ----------
Non-local services
Intra-and interregional................. 1,813,416 2,046,021 1,697,626
International........................... 257,496 260,943 192,335
--------- ---------- ----------
Total................................... 2,070,912 2,306,964 1,889,961
--------- ---------- ----------
Data transmission......................... 192,555 225,823 170,344
Network services.......................... 74,384 429,700 668,839
Other..................................... 57,543 52,059 69,840
--------- ---------- ----------
Gross operating revenues.................. 3,704,962 4,976,833 5,436,260
Value added and other indirect taxes...... (919,523) (1,212,111) (1,298,722)
Discounts................................. (41,537) (54,517) (50,870)
--------- ---------- ----------
Net operating revenue..................... 2,743,902 3,710,205 4,086,668
========= ========== ==========
</TABLE>
There are no customers who contribute more than 5% of gross operating
revenues.
5. COST OF SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Depreciation and amortization.................. 1,101,913 1,223,573 1,274,710
Personnel...................................... 454,953 504,810 488,611
Materials...................................... 53,513 81,887 67,540
Services....................................... 215,491 366,802 528,482
Other.......................................... 9,623 24,928 27,994
--------- --------- ---------
1,835,493 2,202,000 2,387,337
========= ========= =========
</TABLE>
6. SELLING EXPENSE
Included in selling expense are provisions for doubtful customer accounts
receivable of R$1,061, R$9,006 and R$8,957 in 1995, 1996 and 1997,
respectively.
F-13
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
7. OTHER NET OPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
-------- ------- -------
<S> <C> <C> <C>
Taxes other than income taxes.................... (2,721) (1,353) (3,788)
Technical and administrative services............ 212,857 103,990 189,478
Provision for contingencies (Note 23)............ (100,952) (48,972) (58,819)
Fines and expenses recovered..................... 169,867 111,461 49,353
Other............................................ (14,444) 63,734 45,881
-------- ------- -------
264,607 228,860 222,105
======== ======= =======
</TABLE>
Fines and expenses recovered primarily represent penalties collected on past
due accounts receivable and recovery of sales taxes of prior periods. The
amount of penalties collected on past due accounts receivable amounted to
approximately R$86,154, R$106,633 and R$43,381 in 1995, 1996 and 1997,
respectively.
8. NET NONOPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Gain(loss) on disposal of permanent assets............. (4,709) 82,628 9,958
Other income........................................... 708 12,088 5,275
------ ------ ------
(4,001) 94,716 15,233
====== ====== ======
</TABLE>
9. INCOME AND SOCIAL CONTRIBUTION TAXES
As explained in Note 2, as a result of non specific cash and certain non
specific debt not being allocated to the cellular telecommunications business,
the associated interest income and expense was not allocated. As a result,
income tax expense and current tax liabilities have not been allocated to the
discontinued cellular operations in the accompanying financial statements.
Brazilian income taxes comprise federal income tax and the social
contribution tax. In 1995, 1996 and 1997 the rates for income tax were 43%,
25% and 25%, respectively, and social contribution tax were 9.09%, 7.41% and
8.00%, respectively. As a result of legislation enacted in 1996, the social
contribution tax in 1997 was no longer deductible from its own computation
base, nor was it deductible for income tax purposes. The changes produced a
combined statutory rate of 48.18%, 30.56% and 33.00% in 1995, 1996 and 1997,
respectively.
Deferred taxes are provided on temporary differences which include the
effects of indexation adjustments that will not give rise to deductions when
subsequently depreciated, amortized or disposed of.
In prior years the indexation adjustments to permanent assets and
shareholders' equity in accordance with the tax law gave rise to a tax
deductible expense, if the indexation of equity exceeded the indexation of
permanent assets, and to taxable income, called "inflationary profit", if the
indexation of permanent assets exceeded that of equity. In the latter case,
payment of the related tax liability could be deferred until it had been
deemed to have been realized either through depreciation or disposal of the
permanent assets in existence at the time the liability was recorded subject
to a minimum realization rate of 10% per annum (5% per annum prior to 1995).
In 1995, 1996 and 1997, management elected to prepay income taxes on
inflationary profit that it had previously deferred. Brazilian companies
making such a prepayment in relation to 1997 were entitled to utilize
F-14
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
an income tax rate of 10% instead of the then current rate of 25%. Similar
reductions applied to the prepayments in 1995 and 1996. The result was a gain
of R$56,932 and R$6,998 for 1996 and 1997, respectively, from the reduction in
deferred tax liabilities.
The following is an analysis of the income tax expense (benefit):
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Social contribution charge........................ 42,918 108,087 136,553
Income tax........................................ 125,587 270,304 399,117
Deferred taxes.................................... 672 - -
Effect of rate changes on deferred tax............ (46,823) 9,132 -
Early payment incentives.......................... - (56,932) (6,998)
------- ------- -------
Total tax expense................................. 122,354 330,591 528,672
======= ======= =======
</TABLE>
Supplementary information regarding taxes posted directly to shareholders'
equity:
<TABLE>
<CAPTION>
1995 1996 1997
------ -------- --------
<S> <C> <C> <C>
Deferred taxes.................................... - (307,024) (271,469)
Effect of rate changes on deferred tax............ 91,863 (7,872) -
------ -------- --------
91,863 (314,896) (271,469)
====== ======== ========
</TABLE>
The following is a reconciliation of the amount calculated by applying the
combined statutory tax rates to the reported income before taxes and the
reported income tax expense:
<TABLE>
<CAPTION>
1995 1996 1997
------- --------- ---------
<S> <C> <C> <C>
Income before taxes as reported in the
accompanying financial statements.......... 467,290 1,306,307 1,689,092
======= ========= =========
Tax charge at the combined statutory rate... 225,140 399,207 557,400
Permanent additions:
Non-deductible expenses................... 1,628 413 4,936
Permanent exclusions:
Tax exempt income......................... - - (372)
Capitalized interest...................... (59,117) (7,007) (7,734)
Other items:
Effect of rate changes on deferred tax.... (46,823) 9,132 -
Early payment incentives.................. - (56,932) (6,998)
Other incentives.......................... (9,622) (14,427) (20,912)
Other, net................................ 11,148 205 2,352
------- --------- ---------
Income and social contribution taxes as
reported in the accompanying financial
statements................................. 122,354 330,591 528,672
======= ========= =========
Effective rate.............................. 26.2% 25.3% 31.3%
======= ========= =========
</TABLE>
In 1997, the Company characterized part of its dividends proposed for
payment at the end of 1997 as interest on shareholders' funds. As a result,
under Brazilian tax law, it was entitled to treat this part of the dividend as
a deduction for income tax purposes.
F-15
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
The composition of deferred tax assets and liabilities, based on temporary
differences is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
DEFERRED TAX ASSETS:
Provisions for contingencies............................... 23,250 24,338
Provision for pensions..................................... 4,182 8,454
------- -------
Total (see Note 13)........................................ 27,432 32,792
======= =======
DEFERRED TAX LIABILITIES:
Additional indexation expense from 1990.................... 6,525 -
Additional indexation expense from pre-1990................ 127,201 25,224
Others..................................................... 301,048 578,493
------- -------
Total...................................................... 434,774 603,717
======= =======
</TABLE>
All of the other deferred tax liabilities relate to the difference between
the tax basis of permanent assets, which was not indexed for inflation
subsequent to December 31, 1995, and the reporting basis, which includes
indexation through December 31, 1997.
The composition of tax liabilities is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Social contribution tax payable.............................. 34,447 26,415
Federal income tax payable................................... 259 69,670
Deferred tax liabilities..................................... 434,774 603,717
------- -------
Total........................................................ 469,480 699,802
======= =======
Current...................................................... 61,056 133,956
Noncurrent................................................... 408,424 565,846
</TABLE>
10. CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- ---------
<S> <C> <C> <C>
Income and social contribution tax paid.......... 155,833 523,719 545,336
Interest paid.................................... 91,892 62,295 8,168
Cash paid against provisions for contingencies... 21,527 111,760 50,129
Non cash transactions:
Conversion of loans into shares................ 183,874 - -
Tax incentive investment credits received...... 2,040 16,530 53,016
Donations received of property, plant and
equipment..................................... 31,567 10,886 66,769
Conversion of capitalizable funds into share
capital and share premium..................... 203,471 412,278 1,028,654
</TABLE>
11. CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Cash........................................................... 448 288
Bank accounts.................................................. 16,592 56,309
------ ------
17,040 56,597
====== ======
</TABLE>
F-16
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
12. TRADE ACCOUNTS RECEIVABLE, NET
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Accrued amounts............................................ 247,241 230,662
Billed amounts............................................. 225,317 268,315
Allowance for doubtful accounts............................ (8,066) (16,121)
------- -------
464,492 482,856
======= =======
</TABLE>
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1995 1996 1997
----- ------- -------
<S> <C> <C> <C>
Beginning balance..................................... 1,082 1,263 8,066
Provision charged to selling expense.................. 1,061 9,006 8,957
Write-offs............................................ (880) (2,203) (902)
----- ------- -------
Ending balance........................................ 1,263 8,066 16,121
===== ======= =======
</TABLE>
13. DEFERRED AND RECOVERABLE TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Tax deducted at source....................................... 9,370 602
Social contribution tax...................................... 1,011 1,377
Recoverable income tax....................................... 20,246 4,525
Deferred tax assets.......................................... 27,432 32,792
Sales and other taxes........................................ 9,620 3,081
------- -------
67,679 42,377
======= =======
Current...................................................... 46,143 31,054
Noncurrent................................................... 21,536 11,323
</TABLE>
14. OTHER ASSETS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Other debtors................................................ 15,408 14,565
Maintenance inventories...................................... 57,503 58,976
Prepayments.................................................. 18,970 8,775
Recoverable advances......................................... 63,031 58,640
Fiscal incentive investments................................. 6,243 31,120
Other........................................................ 15,419 43,374
------- -------
176,574 215,450
======= =======
Current...................................................... 162,570 175,186
Noncurrent................................................... 14,004 40,264
</TABLE>
F-17
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
15. INVESTMENTS
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Fiscal incentive investments................................... 59,467 90,120
Other investments.............................................. 3,666 3,470
------ ------
63,133 93,590
====== ======
</TABLE>
16. PROPERTY, PLANT AND EQUIPMENT, NET
A. COMPOSITION:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Construction-in-progress........................... 1,374,160 1,383,731
Automatic switching equipment...................... 8,079,031 7,646,253
Other equipment.................................... 9,312,850 9,948,052
Buildings.......................................... 4,739,214 5,011,257
Other assets....................................... 1,917,020 1,989,900
----------- -----------
Total cost......................................... 25,422,275 25,979,193
Accumulated depreciation........................... (13,087,415) (13,389,738)
----------- -----------
Property, plant and equipment, net................. 12,334,860 12,589,455
=========== ===========
</TABLE>
Other equipment includes: Aerial, underground and building cables,
teleprinters, private automatic exchanges, generating equipment and furniture.
Other assets include: Underground cables, computer equipment, vehicles, land
and other assets. Within "Other assets" the book value of land is R$165,889 at
December 31, 1996 and R$170,457 at December 31, 1997.
B. DEPRECIATION RATES
The annual depreciation rates applied to property, plant and equipment are
as follows:
<TABLE>
<CAPTION>
%
----------
<S> <C>
Automatic switching equipment..................................... 7.69
Transmission and other equipment.................................. 10.00
Buildings......................................................... 4.00
Other assets (excluding land)..................................... 5.00-20.00
</TABLE>
C. RENTALS
The Company rents equipment and premises through a number of operating
agreements that expire at different dates. Total annual rent expense under
these agreements was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Rent expense............................................ 32,840 35,136 41,638
====== ====== ======
</TABLE>
F-18
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
Rental commitments relate primarily to facilities where the future minimum
rental payments under leases with remaining noncancelable terms in excess of
one year are:
<TABLE>
<S> <C>
Year ending December 31,
1998................................................................ 13,170
1999................................................................ 7,760
2000................................................................ 5,239
2001................................................................ 4,090
2002................................................................ 2,234
2003 and thereafter................................................. 1,392
------
Total minimum payments.............................................. 33,885
======
</TABLE>
17. PAYROLL AND RELATED ACCRUALS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Wages and salaries........................................... 14,527 31,314
Accrued social security charges.............................. 88,533 92,533
Accrued benefits............................................. 90,698 67,965
Payroll withholdings......................................... 2,386 2,213
------- -------
196,144 194,025
======= =======
</TABLE>
18. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Suppliers................................................... 175,297 196,718
Other accrued expenses...................................... 58,062 68,067
------- -------
233,359 264,785
======= =======
</TABLE>
19. TAXES OTHER THAN INCOME TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Value-added taxes............................................ 196,815 208,817
Other indirect taxes on operating revenues................... 11,575 17,330
------- -------
208,390 226,147
======= =======
</TABLE>
20. DIVIDENDS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Payable to Telebras.......................................... 177,223 181,186
Other........................................................ 86,246 137,386
------- -------
263,469 318,572
======= =======
</TABLE>
F-19
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
21. OTHER LIABILITIES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Prior year dividends not claimed............................. 20,792 30,710
Employees' profit share...................................... 33,342 43,176
Other........................................................ 63,138 94,715
------- -------
117,272 168,601
======= =======
Current...................................................... 87,566 143,110
Noncurrent................................................... 29,706 25,491
</TABLE>
22. LOANS AND FINANCING
<TABLE>
<CAPTION>
1996 1997
--------- -------
<S> <C> <C>
Loans payable to Telebras.................................. 767,163 143,382
Other financing............................................ 360,295 357,614
--------- -------
1,127,458 500,996
========= =======
Current.................................................... 633,352 28,397
Noncurrent................................................. 494,106 472,599
</TABLE>
A. LOANS PAYABLE TO TELEBRAS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Eurobonds, originally issued by Telebras..................... 289,842 142,535
Debentures, originally issued by Telebras.................... 1,487 -
Loans and financing from Telebras............................ 474,985 -
Other debt................................................... 849 847
------- -------
767,163 143,382
======= =======
</TABLE>
A.1 EUROBONDS ORIGINALLY ISSUED BY TELEBRAS
These are represented by three issues, two denominated in US dollars and one
in Italian Lira, as follows:
<TABLE>
<CAPTION>
PRINCIPAL ANNUAL INTEREST
REPAYMENT ORIGINAL INTEREST PAYMENT
ISSUE TERM SCHEDULE VALUE RATE SCHEDULE 1996 1997
----- ---- ------------- ---------------- -------- ----------- ------- -------
(US$ THOUSANDS)
<C> <S> <C> <C> <C> <C> <C> <C>
1 1992/1997............... upon maturity 38,000 10.000% semi annual 42,557 -
2 1992/1997............... upon maturity 54,877 10.375% annual 78,851 -
<CAPTION>
(LIRA THOUSANDS)
<C> <S> <C> <C> <C> <C> <C> <C>
3 1996/1999............... upon maturity 198,167,397 13.000% annual 145,363 125,768
------- -------
Principal.......................................................................... 266,771 125,768
Accrued interest................................................................... 23,071 16,767
------- -------
Total.............................................................................. 289,842 142,535
======= =======
</TABLE>
In addition to the contractual interest, in connection with the Eurobonds,
the Company pays Telebras a 1% per year administrative fee on the outstanding
balances.
F-20
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
A.2 DEBENTURES ORIGINALLY ISSUED BY TELEBRAS
These are represented by two issues, denominated in Brazilian Reais as
follows:
<TABLE>
<CAPTION>
ORIGINAL
ISSUE QUANTITY ISSUANCE MATURITY 1996 1997
----- -------- -------- -------- ----- ----
(UNITS)
<S> <C> <C> <C> <C> <C>
1...................................... 1,874 1988 1998 571 -
4...................................... 120,000 1993 2005 339 -
----- ---
Principal......................................................... 910 -
Accrued interest.................................................. 577 -
----- ---
Total............................................................. 1,487 -
===== ===
</TABLE>
The debentures are subject to an annual correction by the ANBID rate minus
5% points. In addition to these financial expenses, the Company pays Telebras
a 1% per year administrative fee on the outstanding balances.
A.3 LOANS AND FINANCING FROM TELEBRAS
<TABLE>
<CAPTION>
1996 1997
------- ----
<S> <C> <C>
Short term loans with Telebras.................................. 474,071 -
Accrued interest................................................ 914 -
------- ---
474,985 -
======= ===
</TABLE>
The short-term loans were subject to the interest rate on federal treasury
bills (the "Remuneracao Diaria dos Titulos Publicos") plus 0.25%.
B. OTHER FINANCING
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Equipment financing from Comtel.............................. 358,063 356,872
Other........................................................ 2,232 742
------- -------
360,295 357,614
======= =======
</TABLE>
The loan with Comtel Brasileira Ltda. ("Comtel"), a supplier of
telecommunications equipment, is repayable in full on September 26, 2004. The
loan is denominated in US dollars and bears interest at a rate of 10.75% per
annum. The loan is guaranteed by Telebras. As of December 31, 1996 and 1997,
the amount due to Comtel includes R$9,186 and R$9,866 of accrued interest,
respectively.
C. REPAYMENT SCHEDULE
Noncurrent debt is scheduled to be repaid as follows:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
1999................................................................. 126,514
2003 and thereafter.................................................. 346,085
-------
472,599
=======
</TABLE>
F-21
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
D. CURRENCY ANALYSIS
Total debt is denominated in the following currencies:
<TABLE>
<CAPTION>
EXCHANGE RATE
AT DECEMBER 31, 1997 1996 1997
-------------------- --------- -------
(UNITS OF ONE
BRAZILIAN REAL)
<S> <C> <C> <C>
Brazilian Reais....................... - 476,472 -
US dollars............................ 1.1164 485,294 358,462
Italian lira.......................... 0.0006342 165,692 142,534
--------- -------
1,127,458 500,996
========= =======
</TABLE>
The Company does not hedge its foreign currency liabilities.
E. CREDIT AGREEMENT DEFAULTS
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998 and the privatization of the
Company constituted, an event of default under such credit agreements. In
addition, most of the Company's other credit agreements include cross-default
provisions and cross-acceleration provisions that would permit the holders of
such indebtedness to declare the indebtedness to be in default and to
accelerate the maturity thereof if a significant portion of the principal
amount of the Company's debt is in default or accelerated. Substantially all
of the Company's outstanding debt as of December 31, 1997 is in default or
expected to be in default as a result of the privatization. The Company is
currently in negotiations with the appropriate creditors with respect to this
indebtedness.
The consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities
that might be necessary should the Company be unable to renegotiate its credit
agreements. The Company believes that once the privatization is finalized, the
Company's creditors will renegotiate the terms of these credit agreements
and/or provide appropriate waivers regarding such defaults.
23. PROVISIONS FOR CONTINGENCIES
The Company is a party to certain legal proceedings arising in the normal
course of business, including civil, administrative, tax, social security and
labor proceedings. The Company has provided for the amounts to cover its
estimated losses due to adverse legal judgments. In the opinion of management,
such actions, if decided adversely to the Company, would not have a material
adverse effect on the Company's financial condition.
The components of the charge included in the consolidated statements of
income for contingent liabilities are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------- ------ ------
<S> <C> <C> <C>
Additional provisions.................................. 75,814 32,101 44,761
Payments in excess of provisions....................... 25,138 16,871 14,058
------- ------ ------
100,952 48,972 58,819
======= ====== ======
</TABLE>
F-22
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Labor claims................................................... 31,258 63,740
Disputed taxes................................................. 20,495 21,530
Civil claims................................................... 25,420 593
------ ------
77,173 85,863
====== ======
Current........................................................ 13,063 51,623
Noncurrent..................................................... 64,110 34,240
</TABLE>
Labor claims
The provision for labor claims comprises management's estimate of the most
probable loss in relation to various suits filed by current and former
employees.
Tax contingencies
i. Workers Accident Insurance Tax
The Company is a party to several lawsuits filed by the National Institute
of Social Security in 1997 before the Justica Federal of Sao Paulo relating to
the collection of the Seguro de Acidente de Trabalho (Workers Accident
Insurance Tax or "SAT") for the period between January 1986 and June 1996. The
aggregate amount involved in such lawsuits is approximately R$100 million. The
Company has allowed judicial liens to be placed on five of its properties,
valued at approximately R$61.6 million in the aggregate, pursuant to Brazilian
legal procedures pending the outcome of such lawsuits. In the event the
Company prevails in such lawsuits, such liens will be lifted from the
properties. As management believes that the Company will prevail, no provision
has been recorded.
ii. Other taxes
The determination of the manner in which the various federal, state and
municipal Brazilian taxes apply to the operations of the Company is subject to
varying interpretations arising from the unique nature of the Company's
operations. Management believes that its interpretation of the Company's tax
obligations is substantially in compliance with legislation. Accordingly, any
changes in the tax treatment afforded to the Company's operations will be the
result of new legislation or interpretive rulings of the tax authorities that
will, in the opinion of management, not have any retroactive impact. The
amount of disputed taxes provided as of December 31, 1997, relates primarily
to two cases with the tax authorities regarding INSS (an employee compensation
tax) and ICMS (a sales tax). Management believes the likelihood of an
unfavorable outcome is probable and accordingly have made a provision of
R$21,530 at December 31, 1997, representing the total amount of the dispute.
iii. ICMS on activation fees and other services
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS (Imposto sobre Circulacao de Mercadorias e
Servicos), a state value-added tax, to cover not only telecommunications
services, but also other services, including cellular activation fees, which
had not been previously subject to such tax. Pursuant to this new
interpretation of tax law, the ICMS tax may be applied retroactively for such
services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state
F-23
<PAGE>
secretaries acted beyond the scope of their authority; (ii) their
interpretation would subject certain services to taxation which are not
considered telecommunications services; and (iii) new taxes may not be applied
retroactively. No provision for such taxes has been made in the accompanying
consolidated financial statements as the Company does not believe it is
probable that such taxes will be payable for services rendered during the last
five years.
There can be no assurance that the Company will prevail in its position that
the new interpretation by the state treasury secretaries is unlawful. If the
ICMS tax were applied retroactively for five years to activation fees earned
by the discontinued cellular operations, it would give rise to a maximum
liability estimated at R$187,000.
iv. Compensation of overpaid FINSOCIAL against COFINS
A predecessor to the COFINS tax on gross operating revenues, called
FINSOCIAL, was originally introduced at a rate of 0.5% which was subsequently
increased in stages to a rate of 2.0%. The timing of these increases was
successfully challenged in court by a number of Brazilian companies, giving
rise to tax credits on account of past overpayments which could be compensated
against current payments of the similar tax, COFINS. The Company recorded a
credit for the overpaid FINSOCIAL tax in 1995 following both a High Court
ruling decreeing the unconstitutionality of the rate increases and subsequent
legislation allowing the taxpayer to offset the overpaid tax against other
taxes due to the same taxing authority. The Company realized the benefit by
offsetting its overpaid FINSOCIAL against current liabilities to COFINS and
recognized a gain of R$ 52,382 million in 1995.
The Company has not been questioned by the tax authorities in relation to
this offset. However in 1997 the High Court effectively reversed its earlier
decision and decided that the FINSOCIAL tax rate increases were applicable to
service companies. Nevertheless the Company has maintained the credit taken in
1995 on the grounds that telecommunications services in Brazil are exempt from
COFINS in accordance with the third amendment to the Brazilian Constitution of
March 17, 1993 (Art. 155, (S) 3(degrees)) and also because they are considered
to be a basic industry for all legal purposes in accordance with Decree 640 of
March 2, 1962, which continues to be valid. If the Company were to be
successfully challenged by the tax authorities and the FINSOCIAL tax offset
were found to be without legal support, it would be liable to the unpaid
COFINS tax which, together with interest and penalties for late payment, would
comprise a liability amounting to approximately R$ 77,000 as of December 31,
1997, for which no provision has been established in the attached financial
statements.
Other
A class action suit was filed against the Company in 1995 seeking an
injunction against the Company's "servicos 900" (code 900 services). While the
Company believes that it will prevail on the merits in this civil action, the
Company faces an estimated loss in revenues of approximately R$72 million
annually if an injunction is granted.
Telebras, the legal predecessor of the Company, is a defendant in a number
of legal proceedings and subject to other claims and contingencies. Under the
terms of the breakup, liability for any claims arising out of acts committed
by Telebras prior to the effective date of the breakup remains with Telebras,
except for labor and tax claims (for which Telebras and the New Holding
Companies are jointly and severally liable) and any liability for which
specific accounting provisions have been assigned to the Holding Company or
one of the other New Holding Companies. Creditors of Telebras may challenge
this allocation of liability. Management of the Company believes that the
chances of any such claims materializing and having a material adverse
financial effect on the Company are remote and, accordingly, no provision has
been recorded.
Litigation
Management believes it has meritorious defenses to all lawsuits and legal
proceedings in which the Company is a defendant. Based on its evaluation of
such matters, and after consideration of reserves established, management
believes that the resolution of such matters will not have a material adverse
effect on the Company's financial position or results of operations.
F-24
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
24. PROVISION FOR PENSIONS
The Company participates in a multi-employer defined benefit pension and
other post retirement benefit plans administered by the Fundacao Telebras de
Seguridade Social ("Sistel").
Approximately 90% of the Company's employees are covered by these plans. The
Company contributed and charged to expense R$60,112, R$70,014 and R$67,547, in
1995, 1996 and 1997, respectively, in respect of pension fund contributions.
Information from the plan's administrators is not available to permit the
Company to determine its share of unfunded vested benefits, if any. Management
has no intention of withdrawing from these plans, nor is there any intention
to terminate the plans. As a member of a multi-employer plan, the Company's
contributions are not segregated in separate accounts or restricted to provide
benefits only to employees of the Company. The Company is also contingently
liable for the total obligations of the plans. The funded status of the Sistel
Plan is presented below.
As a member of the multi-employer plans, the Company's contributions are not
segregated in separate accounts or restricted to provide benefits only to
employees of the Company. The Company is also contingently liable for the
total obligations of the plans. The funded status of the Sistel plan is
presented below.
The pension benefit is generally defined as the difference between (i) 90%
of the retiree's average salary during the last 36 months indexed to the date
of retirement and (ii) the value of the retirement pension paid by the
Brazilian social security system. For retired employees the initial pension
payment is subsequently adjusted upwards to recognize cost of living increases
and productivity awards granted to active employees. In addition to the
pension supplements, post-retirement health care and life insurance benefits
are provided to eligible pensioners and their dependents.
Contributions to the plans are based on actuarial studies prepared by
independent actuaries under Brazilian regulations. The actuarial studies are
revised periodically to identify whether adjustments to the contributions are
necessary. A summary relating to the overall Sistel plan, in compliance with
accounting principles generally accepted in Brazil, is as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Accumulated pension and other post retirement benefit
obligations.......................................... 3,235,223 3,775,898
Other obligations..................................... 244,724 255,751
--------- ---------
Total obligations................................. 3,479,947 4,031,649
========= =========
Combined plan assets:
Interest bearing deposits........................... 1,849,298 1,714,153
Stocks and shares................................... 1,548,629 2,360,786
Investment properties............................... 376,805 363,305
Loans to beneficiaries.............................. 115,921 123,428
Other investments................................... 56,229 52,195
--------- ---------
Total plan assets................................. 3,946,882 4,613,867
========= =========
Excess of total plan assets over total obligations.... 466,935 582,218
========= =========
</TABLE>
In addition to the formal Sistel plan, the Company pays pension benefits to
684 former employees of CTB, a predecessor company, in accordance with
agreements approved in 1971 and 1972. The Company accounts for the expense of
this agreement on the cash basis because it believes that the actuarially
computed liability and the annual expense are not material to its financial
position or results of operations.
F-25
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
25. SHAREHOLDERS' EQUITY
The consolidated financial statements reflect the shareholders' equity of
the Company, after segregating as minority interests the participation of
minority shareholders in the Company at the historical percentages applicable
to shareholders other than Telebras. The shareholders' equity has been
segregated between capital, reserves and retained earnings.
26. EXPANSION PLAN CONTRIBUTIONS
Expansion plan contributions are the means by which Telesp has financed the
growth of its telecommunications network. The contributions were made by
companies or individuals to be connected to the national telephone network.
Such contributions were paid directly to Telesp and interest received, when
payments were made in installments, was transferred to Telebras. The capital
value received from the prospective telephone subscribers was treated as
follows:
. 80% was capitalized by Telesp in the name of Telebras, with the value
per share issued to Telebras being equal to the equity value per share
of Telesp at the end of the year preceding the capitalization.
. 20% was remitted by Telesp to Telebras in the month following receipt.
. Until December 31, 1995 the total capital value received was indexed
from the month of receipt to the date of the next audited balance sheet
and then capitalized in the name of the prospective subscriber by
Telebras or by Telesp, at a value per share equal to the equity value
per share shown in the audited balance sheet. From January 1, 1996
indexation was no longer applied and, for contracts signed as from that
date, Telebras or Telesp were allowed the option of using a market value
per share, when that was higher than the equity value. Also, as from
June, 1995, the capitalization of expansion plan contributions was
effected by Telesp issuing its own shares to expansion plan subscribers.
Expansion plan contributions of R$406,147, R$698,896, and R$818,992 in 1995,
1996 and 1997, respectively, were received. Expansion plan contributions
approved by the general meeting of shareholders for capitalization and
transfer to shareholders' equity amounted to R$203,471, R$412,278, and
R$1,028,654 in 1995, 1996 and 1997, respectively. The Company's expansion plan
contribution program has been terminated with no new contracts being signed
after June 30, 1997.
In addition to the expansion plans which it promoted directly, Telesp also
sponsored agreements between companies or individuals in a particular
community and independent contractors who undertook the development of the
telecommunications infrastructure required to connect them to the national
telephone network (Community Expansion Plan). The companies or individuals
paid the contractor. On completion of the project Telesp incorporated the
completed equipment into its fixed assets at the appraised value and credited
expansion plan contributions which are then treated in the same manner as the
capital values received from prospective telephone subscribers, as described
above.
27. TRANSACTIONS WITH RELATED PARTIES
The principal related party transactions take place with Embratel in respect
of long-distance telecommunication. The Company has an operating agreement
with Embratel, which defines the charge per minute for inter-or intrastate
long-distance or international telephone calls with origin or destination in
the area specified by the telecommunications concession granted to the Company
by the Federal Government. All charges to customers, including long-distance
are billed by the Company, who transfers the long-distance portion of the
charges to Embratel. As a result, the Company normally has a payable to
Embratel.
F-26
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
Embratel and the cellular companies of Telebras must pay a network usage fee
if they access end customers via the network of the Company. In practical
terms, even though the network usage fee includes the costs of a variety of
network elements and services, the network usage fee primarily reflects the
use of certain facilities of the Company for which Embratel and the cellular
companies do not have adequate substitutes, particularly the local loop
between local exchanges and customers.
In the past, the Company shared revenues for interregional and international
long-distance calls with Embratel rather than charging Embratel a network
usage fee for the use of the Company's network. Under this system, the Company
retained a fixed percentage of the revenues associated with such calls and
paid the balance of the revenues associated with such calls to Embratel. This
system was replaced on April 28, 1998 with the interconnection charge that had
already been in place for interconnection of the Company's network with
cellular networks, under which the Company charges for connection to its
network and usage of its network.
Additionally, as a result of telephone calls to and from the service areas
of other telephone operators, the Company has receivable and payable positions
with other telecommunications service providers in Brazil within the Telebras
group of companies relating to charges for the use the networks belonging to
those telecommunications service providers.
A summary of the balances and transactions with these related parties is as
follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Current assets:
Trade accounts receivable.................................. 8,127 4,540
Other assets............................................... 20,954 14,633
Non current assets
Other assets............................................... 347,175 346,084
Current liabilities:
Loans and financing........................................ 631,848 28,397
Other liabilities.......................................... 86,002 73,472
Dividends.................................................. 177,223 181,186
Non current liabilities:
Loans and financing........................................ 135,315 114,985
Other liabilities.......................................... 85 23
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Net operating revenues............................. 190,510 197,608 351,740
Cost of services................................... 2,253 128,557 240,872
Operating expenses................................. 693 683 2,931
Net interest expense............................... 185,108 77,093 28,785
</TABLE>
Until the breakup of Telebras, the Company and the other companies of the
Telebras system were required to contribute to the research and development
center operated by Telebras and also conducted their own independent research
and development. Following the breakup of Telebras, a private independently
administered research and development center was established. Pursuant to an
agreement signed in May 1998 between the research and development center and
the Company, the Company is obligated to contribute R$98.5 million to the
center during the three years ending May 2001.
Additionally, Telebras charges a 1% per annum administration fee on the
allocation to the Holding Company of debt originally contracted by Telebras.
Telebras has also charged interest on inter company loans at a rate which is
currently the interest rate on federal treasury bills plus 0.25%. These
interest charges are included in the above table as net interest expense.
F-27
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
Other related parties are Federal, State and Municipal Governments. Revenues
from telephone calls made by government bodies and related organizations have
not been included above because details of the type of telephone user were not
maintained.
The balances of amounts invested in government securities or through
government controlled entities are:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Cash and cash equivalents:
Deposits with Banco do Brasil S.A.......................... 716,111 801,748
</TABLE>
The Company believes that all the costs of doing business are reflected in
the financial statements and that no additional expenditures will be incurred
as a result of the cessation of the activities previously performed by
Telebras.
28. COMMITMENTS
At December 31, 1997 the Company had approximately the following capital
expenditure commitments:
<TABLE>
<CAPTION>
EXPECTED YEAR OF EXPENDITURE
----------------------------
<S> <C>
1998............................................................... 1,421,000
1999............................................................... 436,000
</TABLE>
These commitments are to be spent on continuing expansion and modernization
of the system, transmission equipment and data transmission equipment.
29. INSURANCE
At December 31, 1997, in the opinion of management, all significant and high
risk assets and obligations were insured.
30. FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES
Estimated fair values of the Company's financial assets and liabilities have
been determined using available market information and appropriate valuation
methodologies. However, considerable judgment was required in interpreting
market data to produce the estimated fair values. Accordingly, the estimates
presented below are not necessarily indicative of the amounts that could be
realized in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated
fair values.
The fair value information as of December 31, 1996 and 1997 presented below
is based on pertinent information available to management as of those dates.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts at December 31, 1996, such amounts
have been fully indexed to December 31, 1997 and current estimates of fair
values may differ significantly from the amounts shown.
Where no comparison of book versus fair value is presented for a financial
asset or liability line item in the schedule below, no significant difference
in values is believed to exist.
<TABLE>
<CAPTION>
1996 1996 1997 1997
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
------- ------- ------- -------
<S> <C> <C> <C> <C>
Assets:
Other assets:
Deferred tax assets...................... 27,432 16,406 32,792 30,261
Liabilities:
Income taxes............................... 469,480 186,787 699,802 508,502
Loans and financing:
Loans payable to Telebras................ 767,163 784,948 143,382 151,803
Other financing.......................... 360,295 357,084 357,614 373,372
</TABLE>
F-28
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
Cash, cash equivalents, trade accounts receivable and other assets, accounts
payable and accrued liabilities
The carrying value of cash and cash equivalents, trade accounts receivable
and other assets, accounts payable and accrued liabilities are a reasonable
estimate of their fair values. Cash equivalents are represented principally by
overnight-deposits for which the fair values were also considered to be the
same as the carrying value, as also customer accounts receivable, other
assets, accounts payable and accrued liabilities.
Loans and financing
Interest rates that are currently available to the Company for issuance of
debt with similar terms and maturities were used to estimate fair value.
31. EVENTS SUBSEQUENT TO DECEMBER 31, 1997
A. INCORPORATION OF TELESP CELULAR S.A.
At December 31, 1997, Telebras, through its operating subsidiaries was the
principal supplier of public telecommunications services in Brazil, which
included being the leading provider of fixed-line telephone services. On
January 30, 1998 as part of a separation of the telephone business between
fixed and cellular businesses by all of Telebras' subsidiaries, Telesp spun
off the assets and liabilities at December 31, 1997 of its cellular
telecommunications business into a separate company. This new company, called
"Telesp Celular S.A.", was incorporated on January 5, 1998.
B. INCORPORATION OF TELESP PARTICIPACOES S.A.
On May 22, 1998 the shareholders of Telebras approved Telebras' division
into twelve new holding companies using a procedure under Brazilian corporate
law called a cisao ("spin-off"), whereby existing shareholders received shares
in the new companies in proportion to their holdings in Telebras. The new
companies contain the assets and liabilities previously recorded in the
accounts of Telebras, except for the following, which will remain on the books
of Telebras and not be allocated to the new holding companies:
. approximately R$98,000 of net assets which have been attributed to a
newly constituted research foundation that will take over the activities
previously performed by the Telebras Campinas Research and Development
Center; and,
. R$370,000 of net assets that will provide the funds required to
liquidate Telebras, including approximately R$132,000 of retroactive
dividends to be paid to the holders of new shares issued in April 1998,
as a result of the resolution of the disputed capital increase of 1990,
approximately R$50,000 of indemnity payments to employees and
approximately R$87,000 of expenses arising out of the privatization
process.
In addition to approving the allocation of assets and liabilities to the new
holding companies at the May 22, 1998 meeting, the shareholders also approved
a specific structure for the shareholders' equity of each new holding company,
which included an allocation of a portion of the retained earnings of
Telebras. Consequently, the amounts of the balances of capital, reserves and
retained earnings, together with the corresponding assets and liabilities for
the formation of Telesp Participacoes S.A. were established. After Telebras
retained within its own shareholders' equity sufficient retained earnings from
which to pay dividends on its 1997 earnings and in settlement of dividends as
a result of settlement of the 1990 disputed share increase, Telebras allocated
to each New Holding Company the balance of its Retained Earnings in proportion
to the allocated total net assets. This value of allocated retained earnings
does not represent the historical retained earnings of the Holding Companies
and resulted in an increase of R$171,236 in relation to the Company's
historical retained earnings. These values
F-29
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
are shown in the "Spin-off from Telebras" column in the following table. The
first column summarizes the December 31, 1997 consolidated historical balances
of the Company, and the "Holding Company Consolidated Statement" column
summarizes the consolidated balance sheet of Telesp Participacoes S.A. after
the spin-off.
As a result of the legal structure of the spin-off and as allowed under
Brazilian GAAP, a company formed as a result of a cisao will have such
retained earnings in its balance sheet as the parent company shareholders'
resolution adopting the cisao allocates from the parent company to the new
company. Accordingly, upon formation, Telesp Participacoes S.A.'s legal
capital structure was defined by the resolutions approved by the Telebras
shareholders' meeting of May 22, 1998 so that its shareholders' equity of
R$8,278,167 includes retained earnings of R$1,778,980. The allocated retained
earnings and future retained earnings will be the basis from which future
dividends will be payable.
The "Adjustments and Eliminations" column includes (i) the elimination of
the Holding Company's investment in the operating company, (ii) the
elimination of inter company loans, payables and receivables, (iii) the
elimination of the net assets of the discontinued cellular operations and (iv)
the elimination of the minority shareholdings in the discontinued cellular
operations.
<TABLE>
<CAPTION>
HOLDING
DECEMBER 31, 1997 ADJUSTMENTS COMPANY
HISTORICAL SPIN-OFF AND CONSOLIDATED
BALANCES FROM TELEBRAS ELIMINATIONS STATEMENT
----------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equiva-
lents.................. 858,345 439,216 -- 1,297,561
Intercompany receiv-
ables.................. 4,540 1,405 (1,405) 4,540
Other current assets.... 703,729 289,231 (184,080) 808,880
---------- --------- ---------- ----------
Total current assets.. 1,566,614 729,852 (185,485) 2,110,981
Intercompany receiv-
ables.................. 346,084 5,135 (5,135) 346,084
Other noncurrent as-
sets................... 51,587 6,456 -- 58,043
---------- --------- ---------- ----------
Total noncurrent
assets............... 397,671 11,591 (5,135) 404,127
Investment in subsidiar-
ies.................... -- 7,977,188 (7,977,188) --
Other Investment........ 93,590 89,460 -- 183,050
Advances for future cap-
ital increase.......... -- 435,648 (435,648) --
Property, plant and
equipment, net......... 12,589,455 16,011 -- 12,605,466
---------- --------- ---------- ----------
Total permanent
assets............... 12,683,045 8,518,307 (8,412,836) 12,788,516
Discontinued opera-
tions.................. 1,259,819 -- (1,259,819) --
---------- --------- ---------- ----------
Total assets............ 15,907,149 9,259,750 (9,863,275) 15,303,624
========== ========= ========== ==========
LIABILITIES
Intercompany loans and
financing.............. 28,397 343,921 (1,405) 370,913
Other................... 1,405,690 -- (184,080) 1,221,610
---------- --------- ---------- ----------
Total current
liabilities.......... 1,434,087 343,921 (185,485) 1,592,523
Loans and financing..... 472,599 135,996 (5,135) 603,460
Other................... 625,577 -- -- 625,577
---------- --------- ---------- ----------
Total noncurrent
liabilities.......... 1,098,176 135,996 (5,135) 1,229,037
Minority interests...... 3,984,723 -- (360,335) 3,624,388
Share capital........... -- 3,238,421 -- 3,238,421
Capital and reserves.... 7,268,928 -- (7,268,928) --
Income reserves......... -- 3,260,766 -- 3,260,766
Retained earnings....... 1,607,744 1,778,980 (1,607,744) 1,778,980
---------- --------- ---------- ----------
Total shareholders'
equity............... 8,876,672 8,278,167 (8,876,672) 8,278,167
Funds for capitaliza-
tion................... 513,491 501,666 (435,648) 579,509
---------- --------- ---------- ----------
Total liabilities and
shareholders' equity... 15,907,149 9,259,750 (9,863,275) 15,303,624
========== ========= ========== ==========
</TABLE>
F-30
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
The separation of the fixed and cellular telecommunications business and the
formation of the Holding Company have been accounted for as reorganizations of
entities under common control in a manner similar to a pooling of interests.
Brazilian corporate and tax law allows state controlled companies which are
participating in the government's privatization program a three month delay
between the accounting base date for a spin-off and the date on which the
shareholders' meeting approves the spin-off, including the related accounting
basis for the
net assets spun-off. Furthermore, as allowed by Brazilian corporate law, the
amount shown in the "Spin-off from Telebras" column as "Investment in
subsidiaries" was determined based on the balance sheets of those subsidiaries
as of December 31, 1997. As a result, the consolidated financial statements of
the Holding Company for 1998 will include the results of operations and
changes in financial condition of the subsidiaries from January 1, 1998 and
the effects of the cash, other assets and loans and financing allocated from
Telebras as of March 1, 1998.
The capital stock of the Holding Company is comprised of preferred shares
and common shares, all without par value. At May 22, 1998, there were
210,029,997 thousand outstanding preferred shares (inclusive of 13,718,350
thousand preferred shares resulting from the settlement in April 1998 with
Telebras as discussed below) and 124,351,903 thousand outstanding common
shares (net of 17,128 thousand common shares in treasury). The capital may be
increased only by a decision taken at a shareholders' meeting or by the Board
of Directors in connection with the capitalization of profits or reserves
previously allocated to capital increases at a shareholders' meeting.
The preferred shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the common shares in the case of liquidation of the Holding Company.
Under the Brazilian Corporation Law, the number of non-voting shares, such
as the preferred shares, may not exceed two-thirds of the total number of
shares.
Dividends
Pursuant to its By-laws, Telesp Participacoes S.A. is required to distribute
as dividends in respect of each fiscal year ending on December 31, to the
extent amounts are available for distribution, an aggregate amount equal to at
least 25% of Adjusted Net Income (as defined) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of preferred shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of common shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of preferred
shares and common shares.
For purposes of Brazilian Corporation Law, and in accordance with Telesp
Participacoes S.A.'s By-laws, the "Adjusted Net Income" is an amount equal to
Telesp Participacoes S.A.'s net profits adjusted to reflect allocations to or
from (i) the statutory reserve, (ii) a contingency reserve for anticipated
losses, if any, and (iii) an unrealized revenue reserve, if any.
On June 7, 1990 the Board of Directors of Telebras authorized an increase in
the Company's share capital by public offer. During the offer period the CVM
initiated an investigation as to whether Brazilian securities law and
regulations regarding the correct pricing of the new shares issued had been
violated because the shares were issued at a discount to equity value per
share. After its investigation the CVM notified the Federal Prosecutor's
Office that it believed no violation occurred since the price was established
in line with market prices for Telebras shares traded on the Brazilian stock
exchanges. Nevertheless, the Federal Prosecutor decided to pursue the issue
F-31
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
through judicial channels. In April 1998, resolution was reached on the
disputed Telebras capital increase of 1990. In connection with the resolution,
Telebras issued 13,718,350 thousand shares of preferred stock.
Loans and Financing
The loans and financing transferred from Telebras comprise financing from
various banks and suppliers of telecommunications equipment, as follows:
<TABLE>
<CAPTION>
BALANCE AT
ANNUAL DECEMBER 31,
CURRENCY INTEREST RATE MATURITY 1997
--------------- ------------- -------- ------------
<S> <C> <C> <C> <C>
Medio credito U.S. Dollar 1.75% 2014 49,819
Citibank U.S. Dollar Various 2024 6,004
EDC--Tranche A U.S. Dollar 11.55% 2001 4,215
EDC--Tranche B U.S. Dollar LIBOR + 1.5% 2001 848
EDC II U.S. Dollar LIBOR + 1.0% 2002 62,098
EDC III U.S. Dollar LIBOR + 1.0% 2002 36,416
CIDA Canadian Dollar 3.00% 2005 1,095
J.P. Morgan Italian Lira 13.00 1999 319,462
-------
479,917
=======
Current portion 343,921
Non-current portion 135,996
</TABLE>
C. NEW REGULATORY ENVIRONMENT
On April 28, 1998 the revenue sharing regime used to divide interregional
and international long-distance revenues between Embratel and the Company was
replaced with a network usage fee for interconnection, based on the terms of
an interconnection agreement with Embratel which became effective in April
1998.
The terms of this interconnection agreement, particularly pricing and
technical requirements, will significantly affect the Company's results of
operations, competitive environment and capital expenditure policies. Under
the current regulatory framework, all telecommunications service providers
must provide interconnection services on a non-discriminatory basis. Subject
to certain requirements, providers are free to negotiate the terms of
interconnection but, in the event the parties fail to reach an agreement,
Anatel will establish the terms of interconnection.
The Company does not expect the terms of the interconnection agreement to
have a material impact on net income initially as reduced net operating
revenues under the new structure are expected to be offset by a supplemental
per-minute rebate from Embratel called Parcela Adicional de Transicao ("PAT")
that supplements the network usage charge. Under the General Plan on
Concessions and Licenses, the fixed-line companies and Embratel, an affiliate
providing long distance services, are prohibited from offering certain basic
fixed-line telecommunications services until they fulfill certain specified
obligations. Embratel is prohibited from offering local or cellular services
and the regional fixed-line companies are prohibited from offering cellular,
interregional long-distance and international long-distance services. After
the privatization is effected, Embratel will be allowed to enter the market
for intraregional long-distance service as a competitor to the regional fixed-
line companies once the privatization of Telebras is completed.
D. CHANGE IN CONTROL (UNAUDITED)
On July 29, 1998, the Federal Government sold to twelve separate buyers (the
"New Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such
F-32
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
shares. In connection with this sale, the Federal Government assigned to the
New Controlling Shareholders substantially all its economic and voting rights
with respect to the New Holding Companies and, as a consequence, effective
August 4, 1998 the New Controlling Shareholders control the New Holding
Companies.
32. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND US GAAP
The Company's accounting policies comply with generally accepted accounting
principles in Brazil ("Brazilian GAAP"). Accounting policies which differ
significantly from generally accepted accounting principles in the United
States of America ("US GAAP") are described below:
A. DIFFERENT CRITERIA FOR CAPITALIZING AND DEPRECIATING CAPITALIZED INTEREST
Until December 31, 1993 capitalized interest was not added to the individual
assets in property, plant and equipment, instead it was capitalized separately
and amortized over a time period different from the useful lives of the
related assets. Under US GAAP, capitalized interest is added to the individual
assets and is amortized over their useful lives. Also, under Brazilian GAAP as
applied to companies in the telecommunications industry, interest attributable
to construction-in-progress is computed at the rate of 12% per annum of the
balance of construction-in-progress and that part which relates to interest on
third party loans is credited to interest expense based on actual interest
costs with the balance relating to own capital being credited to capital
reserves.
Under US GAAP, in accordance with the provisions of SFAS 34, interest
incurred on borrowings is capitalized to the extent that borrowings do not
exceed construction-in-progress. The credit is a reduction of interest
expense. Under US GAAP, the amount of interest capitalized excludes the
monetary gain associated with the borrowings and the foreign exchange gains
and losses on foreign currency borrowings. The US GAAP differences between the
accumulated capitalized interest on disposals and in accumulated amortization
on disposals relate to the differences between capitalized interest and
related accumulated amortization under Brazilian and US GAAP which is included
in the net book value of disposed property, plant and equipment. Although
these amounts have been determined to be the same, they are presented
individually in both the determination of the capitalized interest difference
and in the determination of the amortization of the capitalized interest
difference in order to demonstrate the origin of the reconciling items for
capitalized interest and amortization of capitalized interest which are
disclosed in the net income reconciliation of the differences between US and
Brazilian GAAP.
F-33
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
The effects of these different criteria for capitalizing and depreciating
capitalized interest are presented below:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
CAPITALIZED INTEREST DIFFERENCE
US GAAP capitalized interest:
Interest which would have been capitalized and credited
to income under US GAAP (Being interest incurred on
loans from the Company's parent and from third
parties, except in years where total loans exceeded
total construction in progress, when capitalized
interest is reduced proportionately).................. 117,428 88,600
Difference in accumulated capitalized interest on
disposals............................................. 2,854 15,275
-------- --------
120,282 103,875
-------- --------
Less Brazilian GAAP capitalized interest:
Interest capitalized and credited to income under
Brazilian GAAP (Up to the limit of interest incurred
on loans obtained for financing capital investments).. (20,864) (15,013)
Interest capitalized and credited to reserves under
Brazilian GAAP (Difference between total capitalized
interest and interest capitalized and credited to
income)............................................... (172,469) (148,308)
-------- --------
Total capitalized interest under Brazilian GAAP (12%
per annum, applied monthly to the balance of
construction-in-progress)........................... (193,333) (163,321)
-------- --------
US GAAP Difference..................................... (73,051) (59,446)
======== ========
AMORTIZATION OF CAPITALIZED INTEREST DIFFERENCE
Amortization under Brazilian GAAP...................... 204,360 228,727
Less: Amortization under US GAAP....................... (175,639) (187,299)
US GAAP difference in accumulated amortization on
disposals........................................... (2,854) (15,275)
-------- --------
US GAAP Difference..................................... 25,867 26,153
======== ========
</TABLE>
B. REVERSAL OF PROPOSED DIVIDENDS
Under Brazilian GAAP proposed dividends are accrued for in the financial
statements in anticipation of their approval at the shareholders' meeting.
Under US GAAP, dividends are not accrued until they are formally declared.
C. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Company participates in a multi-employer plan ("Sistel") and provides
for the costs of pensions and other post retirement benefits based on a fixed
percentage of remuneration, as recommended annually by independent actuaries.
For the purposes of US GAAP, the Company is considered to contribute to a
multiemployer plan and consequently is required to disclose its annual
contributions and the funded status of the plan in accordance with US GAAP.
Note 33 shows the funded status of Sistel. The provisions of SFAS No. 87, for
the purposes of calculating the funded status, were applied with effect from
January 1, 1992, because it was not feasible to apply them from the effective
date specified in the standard.
F-34
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
D. ITEMS POSTED DIRECTLY TO SHAREHOLDERS' EQUITY ACCOUNTS
Under Brazilian GAAP various items are posted directly to shareholders'
equity accounts, that, under US GAAP, would be posted to the income statement.
Examples include capitalized interest, the effects of adjustments to tax rates
and tax incentive investment credits received. The posting of such items to
shareholders' equity in the subsidiaries gives rise to consolidation
adjustments in the statements of changes in shareholders' equity. Since the
original postings equity accounts would, under US GAAP, be made directly to
the income statement, these consolidation adjustments must be included in the
reconciliation of net income in accordance with US GAAP. The effects of
changes in income tax rates posted directly to shareholders' equity accounts
arises from applying increases or decreases in tax rates to the deferred tax
liability relating to the special reserve arising from pre-1990 indexation
adjustments to property, plant and equipment.
E. EARNINGS PER SHARE
Under Brazilian GAAP, net income per share is calculated on the number of
shares outstanding at the balance sheet date. Since the capital structure of
the Holding Company was not in place at December 31, 1997, earnings per share
is not presented for Brazilian GAAP.
In these consolidated financial statements, information is disclosed per lot
of one thousand shares, because this is the minimum number of shares that can
be traded on the Brazilian stock exchanges. Each American Depositary Share
("ADS") is equivalent to one thousand shares.
As discussed in Note 1, the Company was not formed until subsequent to
December 31, 1997. For US GAAP purposes, the equity structure utilized for the
earnings per share computations is that of the new entity formed in May 1998.
The Holding Company's equity structure has been used for all years presented.
At the date of formation, the company had 124,351,903 thousand common shares
(net of 17,128 thousand common shares in treasury) and 196,311,647 thousand
preferred shares outstanding (exclusive of the 13,718,350 thousand preferred
shares resulting from the settlement in April 1998 with Telebras).
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share". This new statement became effective December 15,
1997, and provides computation, presentation and disclosure requirements for
earnings per share.
Since the preferred and common stockholders have different dividend, voting
and liquidation rights, Basic and Diluted earnings per share have been
calculated using the "two-class" method. The "two-class" method is an earnings
allocation formula that determines earnings per share for preferred and common
stock according to the dividends to be paid as required by the Company's by-
laws and participation rights in undistributed earnings.
Basic earnings per common share is computed by reducing net income by
distributable and undistributable net income available to preferred
shareholders and dividing net income available to common shareholders by the
weighted-average number of common shares outstanding during the period. Net
income available to preferred shareholders is the sum of the preferred stock
dividends up to a minimum of 6% of adjusted net income (as defined in the
Company's by-laws) (distributable net income) and the preferred shareholders'
portion of undistributed net income. Undistributed net income is computed by
deducting preferred stock dividends and common stock dividends from net
income. Undistributed net income is shared equally by the preferred and common
shareholders on a pro rata basis. Common stock dividends are calculated as up
to 25% of adjusted net income or an amount equal to the preferred stock
dividend, whichever is less. Diluted earnings per share is computed by
reducing net income for an increase to net earnings allocated to minority
shareholders and dividing such net income available to common and preferred
shareholders by the monthly weighted-average number of common and preferred
shares outstanding during the period. The weighted-average (thousand) shares
outstanding
F-35
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
for diluted earnings per share is not greater than such shares used in the
basic earnings per share calculation since the dilutive share issue is that of
the Holding Company's subsidiary Telesp, as indicated below.
The weighted-average number of common and preferred shares used in computing
basic earnings per share for 1997 was 124,351,903 thousand and 196,311,647
thousand (exclusive of the 13,718,350 thousand preferred shares resulting from
the settlement in April 1998 with Telebras), respectively. The Company has
received certain contributions from customers or customers have independently
paid suppliers of telecommunications equipment and services for the
installation of fixed line services. These amounts are reflected as "funds for
capitalization" in the accompanying consolidated balance sheets. Once the
installation is essentially complete and the contributions have been received,
the funds will be converted into equity (see Note 26 to the consolidated
financial statements). These activities are dilutive in nature to the
shareholders of the Company, whether the shares to be issued are those of the
Holding Company's subsidiary, Telesp (which will impact the minority interest
recognized) or of the Company itself. The expectation is that the shares would
be issued in the subsidiary companies rather than in the Holding Company based
on the manner in which such shares were issued in 1997 and 1998. Management of
the Holding Company determined this manner of issuing the shares in these two
years was appropriate as a result of the dilution of the Brazilian
Government's share of the ordinary voting shares of the Holding Company below
the 50% level which would have occurred if the shares had been issued by the
Holding Company. The shares are treated as outstanding and included in the
basic EPS calculation only when such funds are converted to equity and the
shares issued. The shares are treated as outstanding for diluted EPS purposes
when expansion plan contributions are received or when Community Expansion
Plan agreements have been approved (see note 26). If subsidiary shares had
been issued historically, the reduction to net income to increase net earnings
allocated to minority shareholders for 1996 and 1997 would have been R$84,427
and R$37,922, respectively.
The Company's preferred shares are non-voting except under certain limited
circumstances and are entitled to a preferential, noncumulative dividend and
to priority over the common shares in the event of liquidation of the Company.
The preferred shareholders were entitled to a non-cumulative dividend of
R$0.82 and R$0.99 per preferred share in 1996 and 1997, respectively. The
preferred shareholders would share equally in the undistributed earnings of
the Company in the amount of R$1.41 and R$1.87 per preferred share in 1996 and
1997, respectively.
In April 1998, resolution was reached on the disputed capital increase of
1990 (see Note 31b). In connection with the resolution, the Company issued
13,718,350 shares of preferred stock. For Brazilian GAAP and US GAAP, such
shares are considered outstanding when issued.
Earnings per share has been presented for net income only since interest
income, certain interest expense and social contribution taxes have not been
allocated between income from continuing operations and income from
discontinued operations.
F. DISCLOSURE REQUIREMENTS
US-GAAP disclosure requirements differ from those required by Brazilian
GAAP. However, in these consolidated financial statements, the level of
disclosure has been expanded to comply with US-GAAP.
G. INCOME TAXES
Telesp fully accrues for deferred income taxes on temporary differences
between tax and reporting records. The existing policies for providing for
deferred taxes are substantially in accordance with SFAS 109, "Accounting for
Income Taxes", except in connection with the deferred income tax effects of
indexation adjustments in 1996
F-36
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
and 1997 (see Note 2(a)(iii)). Under US GAAP the deferred tax effects of the
1996 and 1997 indexation for financial reporting purposes would be charged to
income and social contribution taxes in the statement of income. Consequently,
this is the only material difference in the implementation of SFAS 109 other
than in relation to the US GAAP adjustments described in this note to the
financial statements, and for the fact that deferred income taxes are shown
gross rather than being netted as required by US GAAP. Additionally, for US
GAAP purposes, deferred tax assets and liabilities are classified as current
or non current based on the classification of the asset or liability
attributing to the temporary difference.
H. INTEREST INCOME (EXPENSE)
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest income (expense) would be shown after operating income.
I. EMPLOYEES' PROFIT SHARE
Brazilian GAAP requires employees' profit share to be shown as an
appropriation of net income for the year. Under US GAAP employee profit
sharing is included as an expense in arriving at operating income.
J. PERMANENT ASSETS
Brazilian GAAP has a class of assets called permanent assets. This is the
collective name for all assets on which indexation adjustments were calculated
in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP
the assets in this classification would be noncurrent assets.
Gains on the disposal of permanent assets were R$82,628 and R$9,958 in 1996
and 1997, respectively. For Brazilian GAAP, the gain on disposal of permanent
assets includes the difference between the net book value of the assets
retired from service and the values of the refurbished assets returned to
service at replacement cost values. Such gains are classified as non-operating
income for Brazilian GAAP. Under US GAAP, since assets requiring refurbishment
are not disposed of, the refurbishment activities would not give rise to gain
on disposal. Under US GAAP refurbishment costs meeting the criteria of
capitalization would be added to the cost of the related asset and amortized
over its remaining useful life. The net book value of the refurbished
equipment under Brazilian GAAP does not exceed that under US GAAP,
accordingly, no US GAAP adjustment is reflected in the US GAAP reconciliation.
Additionally, under US GAAP, the difference between the net book value of the
assets retired from service and the value of the refurbished assets returned
to service, amounting to R$88,145 and R$6,182 in 1996 and 1997, would be a
reduction of the corresponding refurbishment expenses (classified as cost of
services under Brazilian GAAP) rather than a credit to gains on the disposal
of permanent assets (classified as nonoperating income (expense) under
Brazilian GAAP).
K. PRICE-LEVEL ADJUSTMENTS AND US GAAP PRESENTATION
The effects of price-level adjustments have not been eliminated in the
reconciliation to US GAAP nor are the monetary gains or losses associated with
the various US GAAP adjustments separately identified, because the application
of inflation restatement as measured by the UFIR and the IGP-M represents a
comprehensive measure of the effects of price level changes in the Brazilian
economy and, as such, is considered a more meaningful presentation than
historical cost-based financial reporting for both Brazilian and US accounting
purposes.
L. FUNDS FOR CAPITALIZATION
i. Expansion plan contributions
Under Brazilian GAAP, expansion plan contributions received are included in
the consolidated balance sheet below equity until proposed subscribers have
paid for their telephone connection in full and a general
F-37
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
meeting of shareholders approves the capital increases. Until December 31,
1995 expansion plan contributions were indexed from the month received to the
date of the next audited balance sheet and transferred to equity when capital
stock was issued to the subscriber, at a value per share equal to the equity
value per share shown on the latest audited balance sheet.
From January 1, 1996 indexation was no longer applied and, for contracts
signed as from that date, Telesp was allowed the option of using a value per
share equal to the market value, when this is higher than the equity value.
For US GAAP purposes, a portion of the expansion plan contributions would be
allocated to shareholders' equity based on the market value of the shares to
be issued to subscribers. The remainder of the expansion plan contributions
would be classified as a deferred credit and amortized to reduce depreciation
expense from the time the related construction-in-progress is completed.
ii. Donations and subsidies for investments
Under Brazilian GAAP those amounts, which comprise principally the excess of
the value of property, plant and equipment incorporated into the Company's
assets over the corresponding credits to expansion plan contributions
received, are recorded as a credit to other capital reserves. For US GAAP
purposes, the credit to capital reserves would be classified as a deferred
credit and amortized to reduce depreciation expense.
M. LOANS AND FINANCING
For US GAAP, loans and financing balances in default or expected to be in
default within a year of the balance sheet date would be classified as current
obligations unless creditors had provided the Company waivers for such
defaults. For Brazilian GAAP, loans and financing balances in technical
default are not always classified as current liabilities. All (R$483,487) of
the Company's outstanding debt at December 31, 1997 is currently in default or
is expected to be in default as a result of the privatization and accordingly,
for US GAAP, would be classified as current liabilities.
N. VALUATION OF LONG-LIVED ASSETS
For US GAAP, effective January 1, 1996 the Company adopted SFAS 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." In accordance with this standard, the Company periodically
evaluates the carrying value of long-lived assets to be held and used, when
events and circumstances warrant such a review. The carrying value of long-
lived assets is considered impaired when the anticipated undiscounted cash
flow from such assets is separately identifiable and is less than their
carrying value. In that event, a loss is recognized based on the amount by
which the carrying value exceeds the fair market value of the assets. The
adoption of this standard did not have a material effect on the Company's
results or financial condition.
Brazilian GAAP does not require cash flow computations in order to determine
potential asset impairment.
O. RETAINED EARNINGS
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under US GAAP, "retained earnings" allocated in
the cisao would not be considered historical retained earnings as such amount
would represent capital allocated from the parent company and would be
described as "distributable capital." As a result of the May 22, 1998 spin-
off, the Company will have US GAAP distributable capital of R$1,778,980.
F-38
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in millions of Brazilian Reais, of December 31, 1996)
P. RECOGNITION OF GAINS FROM DISPUTED TAXES
Brazilian GAAP is less rigorous than US GAAP in establishing the criteria
which must be met for the recognition of a gain such as the R$52,382 recognized
by the Company in 1995 in relation to overpaid FINSOCIAL taxes (see Note 23).
Under US GAAP this amount would be considered a gain contingency which would
not be recognized until receipt of the benefit were to be considered full and
final.
NET INCOME RECONCILIATION OF THE DIFFERENCE BETWEEN US AND BRAZILIAN GAAP
<TABLE>
<CAPTION>
1996 1997
R$ R$
----------- -----------
<S> <C> <C>
Income from continuing operations, before unallocated
interest income/expense, taxes and minority
interests........................................... 930,661 952,296
Add (deduct):
Different criteria for:
Capitalized interest............................. (73,051) (59,446)
Amortization of capitalized interest............. 25,867 26,153
Contributions to plant expansion:
Amortization of deferred credit.................. 18,543 19,709
Donations and subsidies for investment........... -- (32,621)
Interest on construction in progress............... 167,446 135,805
Consolidation adjustments.......................... 4,702 43,487
----------- -----------
US GAAP income from continuing operations before
unallocated interest income/expense, income taxes
and minority interests.............................. 1,074,168 1,085,383
----------- -----------
Income from discontinued operations before
unallocated interest income/expense, income taxes
and minority interests as reported.................. 328,741 537,377
Effect of US GAAP differences on income from
discontinued operations........................... 5,748 49
----------- -----------
US GAAP income from discontinued operations before
unallocated interest income/expense, income taxes
and minority interests.............................. 334,489 537,426
----------- -----------
Items relating to continuing and discontinued
operations:
Unallocated interest income......................... 98,405 202,751
Unallocated interest expense........................ (51,500) (3,332)
Income and social contribution taxes................ (330,591) (528,672)
Minority interests, Brazilian GAAP basis............ (249,855) (360,296)
Add (deduct):
Items posted directly to shareholder's equity:
Effects of changes in income tax rates........... (7,872) --
Deferred tax on full indexation.................. (307,024) (271,469)
Tax incentive investment credits................. 16,530 53,016
Deferred tax effects of the above adjustments:
In respect of continuing operations.............. 21,916 18,326
In respect of discontinued operations............ (212) 4,110
CTBC minority interests in the above adjustments... 6,207 11,931
Telesp minority interests in the above
adjustments....................................... 109,492 169,331
----------- -----------
US GAAP net income................................... 714,153 918,505
=========== ===========
NET INCOME PER THOUSAND SHARES IN ACCORDANCE WITH US
GAAP
Common shares--Basic................................. 2.86 2.23
=========== ===========
Weighted average (thousand) common shares outstand-
ing............................................... 124,351,903 124,351,903
Common shares--Diluted............................... 1.96 2.75
=========== ===========
Weighted average (thousand) common shares outstand-
ing............................................... 124,351,903 124,351,903
Preferred shares--Basic.............................. 2.86 2.23
=========== ===========
Weighted average (thousand) Preferred shares out-
standing.......................................... 196,311,647 196,311,647
Preferred shares--Diluted............................ 1.96 2.75
=========== ===========
Weighted average (thousand) Preferred shares out-
standing.......................................... 196,311,647 196,311,647
</TABLE>
F-39
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
SHAREHOLDERS' EQUITY RECONCILIATION OF THE DIFFERENCE BETWEEN US AND BRAZILIAN
GAAP
<TABLE>
<CAPTION>
1996 1997
R$ R$
----------- -----------
<S> <C> <C>
Total shareholders' equity as reported................ 8,168,335 8,876,672
Add (deduct):
Different criteria for:
Capitalized interest.............................. (344,315) (403,761)
Amortization of capitalized interest.............. 145,425 171,578
Reversal of proposed dividends...................... 263,469 318,572
Reversal of COFINS tax credit....................... (52,382) (52,382)
Contributions to plant expansion:
Amortization of deferred credit................... 55,727 75,436
Subscribed capital stock.......................... 559,710 328,661
Donations and subsidies for investment............ (81,113) (122,497)
Deferred tax effects of above adjustments........... 144,596 162,922
CTBC minority interest in the above adjustments..... 39,873 61,037
Adjustments in respect of discontinued operations:
Adjustments before income taxes................... (430) (12,884)
Deferred tax effects of these adjustments......... 143 4,252
Telesp minority interest in the above adjustments... (139,617) (110,455)
----------- -----------
US GAAP shareholders' equity.......................... 8,759,421 9,297,151
=========== ===========
US GAAP supplementary information:
Total assets........................................ 14,436,069 15,829,256
=========== ===========
Property, plant and equipment....................... 25,077,960 25,575,432
Accumulated depreciation............................ (12,941,990) (13,218,160)
----------- -----------
Net property, plant and equipment................... 12,135,970 12,357,272
=========== ===========
</TABLE>
The deferred tax effect of the US GAAP adjustments noted above would be
classified mainly as a noncurrent asset in the balance sheet.
F-40
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY IN ACCORDANCE WITH
US GAAP
<TABLE>
<CAPTION>
CAPITAL AND RETAINED
RESERVES EARNINGS TOTAL
----------- --------- ---------
<S> <C> <C> <C>
Balances at December 31, 1995................ 6,155,597 1,533,694 7,689,291
Expansion plan contributions:
Received.................................... 696,965 -- 696,965
Deferred credits............................ (1,384) -- (1,384)
Net income................................... -- 714,153 714,153
Realization of unrealized income............. (242,240) 242,240 --
Transfers to reserves........................ 43,792 (43,792) --
Dividends paid............................... -- (230,556) (230,556)
Minority interest in Telesp on all movements
in shareholders' equity, except for net
income...................................... (79,536) (29,512) (109,048)
--------- --------- ---------
Balances at December 31, 1996................ 6,573,194 2,186,227 8,759,421
Expansion plan contributions:
Received.................................... 798,172 -- 798,172
Deferred credits............................ (567) -- (567)
Net income................................... -- 918,505 918,505
Realization of unrealized income............. (206,511) 206,511 --
Transfers to reserves........................ 72,992 (72,992) --
Dividends paid............................... -- (262,247) (262,247)
Minority interest in Telesp on all movements
in shareholders' equity, except for net
income ..................................... (667,710) (248,423) (916,133)
--------- --------- ---------
Balances at December 31, 1997................ 6,569,570 2,727,581 9,297,151
========= ========= =========
</TABLE>
F-41
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
33. ADDITIONAL DISCLOSURES REQUIRED BY US GAAP
A. PENSION AND POST-RETIREMENT BENEFITS
The Company, together with other companies in the Telebras group, sponsor
multi-employer defined benefit pension and other post-retirement benefit
plans, which are operated and administered by Sistel. The funded status of the
Sistel pension and other post-retirement benefit plans and the related
actuarial assumptions in accordance with US GAAP are as follows:
Pension benefit plan
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Funded status:
Accumulated benefit obligation:
Vested......................................... 1,793,943 1,919,975
Non vested..................................... 3,250,909 3,479,300
---------- ----------
Total........................................ 5,044,852 5,399,275
========== ==========
Projected benefit obligation..................... 6,636,907 7,258,074
Fair value of plan assets........................ (3,430,572) (3,897,051)
---------- ----------
Projected obligation in excess of assets......... 3,206,335 3,361,023
========== ==========
The actuarial assumptions used were as follows:
Discount rate for determining projected benefit
obligations..................................... 6.00% 6.00%
Rate of increase in compensation levels.......... 3.25% 3.25%
Expected long-term rate of return on plan
assets.......................................... 6.00% 6.00%
</TABLE>
The above are real rates and exclude inflation.
Amortization of the unrecognized liability at transition: 18.94 years
commencing on January 1, 1991.
OTHER POST-RETIREMENT BENEFITS PLAN
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Funded status:
Accumulated post-retirement benefit obligations:
Retirees and dependents............................ 371,125 380,561
Fully eligible active plan participants............ 32,631 34,589
Other active plan participants..................... 885,917 997,791
--------- ---------
1,289,673 1,412,941
Fair value of plan assets............................ (76,600) (96,141)
--------- ---------
Funded status........................................ 1,213,073 1,316,800
========= =========
</TABLE>
Amortization of the unrecognized liability at transition: 18.84 years
commencing on January 1, 1992.
Health care cost trend rates of increase were projected at annual rates
excluding inflation ranging from 6.48% in 1998 decreasing to 2.00 % in 2047.
The effect of a one percent annual increase in the assumed health care cost
trend rates would increase the accumulated post-retirement benefits obligation
at December 31, 1997 by R$237,063. Measurement of the accumulated post-
retirement benefit obligation was based on the same assumptions as were used
in the pension calculations.
F-42
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
The funded status of the pension and post retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumptions permitted under Brazilian and US GAAP.
The net assets of the plans differ under Brazilian and US GAAP principally
due to the accrual of income tax contingencies of the pension fund for US GAAP
purposes in the amount of R$400,370 and R$487,269 in 1996 and 1997,
respectively. The contingency arises out of uncertainty as to the income tax
status of Brazilian pension funds in general because the tax law is unclear as
to whether these funds are exempt from tax on their investment gains. Under
Brazilian GAAP two methods of accounting for the income tax contingency are
currently permitted. The tax is either deducted from plan assets for the
purposes of determining the funded status of the plan or it is not deducted
but is disclosed in a note as being a contingency. Management of the pension
fund have determined that the Brazilian GAAP financial statements of the fund
be prepared on the basis that the legal arguments against assessment of the
tax on the investment gains are sufficiently strong as to avoid the need for
the potential liability to be recognized. However, for US GAAP purposes,
management of the Company believe that the assessment of this potential income
tax liability is probable. Accordingly, in determining the funded status for
US GAAP purposes, the potential income tax liability (calculated in accordance
with SFAS 109) has been deducted from the fair value of the plan assets.
B. CONCENTRATION OF RISK
The Company is prohibited from investing any surplus cash balances in
financial instruments other than government securities controlled by the
Central Bank of Brazil or the Federal Government owned bank, Banco do Brasil
S.A. There have been no losses in cash equivalents.
Credit risk with respect to customer accounts receivable is diversified. The
Company continually monitors the level of customer accounts receivable and
limits the exposure to bad debts by cutting access to the telephone network if
any invoice is one month past due. Exceptions comprise telephone services that
must be maintained for reasons of safety or national security.
For conducting its business, the Company is fully dependent upon the fixed-
line telecommunications concession as granted by the Federal Government.
Approximately 54% of all employees are members of state labor unions
associated either with the Federacao Nacional dos Trabalhadores em
Telecomunicacoes--Fenattel, or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes--Fittel. Management negotiates a new
collective labor agreement every year with the local union. The collective
agreement currently in force expires in November 1998.
There is no concentration of available sources of labor, services,
concessions or rights, other than those mentioned above, that could, if
suddenly eliminated, severely impact the Company's operations.
C. NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME"
SFAS No. 130 establishes the standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
as part of a full set of financial statements. This statement requires that
all elements of comprehensive income be reported in a financial statement that
is displayed with the same prominence as other financial statements.
SFAS NO. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION"
SFAS No. 131 establishes the standards for the manner in which public
enterprises are required to report financial and descriptive information about
their operating segments. The standard defines operating segments as
components of an enterprise for which separate financial information is
available and evaluated regularly as a
F-43
<PAGE>
TELESP PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of Brazilian Reais, of December 31, 1997)
means for assessing segment performance and allocating resources to segments.
A measure of profit or loss, total assets and other related information are
required to be disclosed for each operating segment. In addition, this
standard requires the annual disclosure of: information concerning revenues
derived from the enterprise's products or services; countries in which it
earns revenues or hold assets, and major customers.
SFAS NO. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS"
SFAS No. 132 revises and standardizes employers' disclosures about pension
and other postretirement benefit plans. It does not change the measurement or
recognition of those plans.
The Company will comply with the requirements of SFAS 130, 131 and 132 in
1998.
F-44
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Telesp Participacoes S.A.
We hereby consent to the use of our report included herein.
/s/ KPMG Peat Marwick
Brasilia, Brazil
October 29, 1998
